Better growth, tougher returns
- 2019 was a year of slowing growth and surprisingly good market returns. We expect things to reverse in 2020.
- Global growth and interest rates should rise only modestly from their current low levels.
- Equity market returns may remain capped by lackluster earnings growth and toppy valuations.
- Investors may already be overrating the impact of the 2020 U.S. election on the economy and markets.
Despite all the noise and disappointment, risk assets performed quite well last year. While still acutely sensitive to recession risks, global stocks continued to make new all-time highs, and as of early December had not experienced a correction of more than 7% in 2019. Most of 2019’s gains came as a result of waning policy risks (e.g., U.S./China trade talks resuming in the fall) or firmer evidence that the U.S. economy would avoid recession. As a result of the simultaneous rally in both stock and bond prices, investors hold a more expensive-looking mix of asset classes than they did at the beginning of the year. So while the path for economic growth looks clearer, markets will be challenged to match 2019’s performance.
Don’t look for things to speed up in 2020
The global economy is growing at its slowest rate in a decade in 2019, and we are forecasting only a modest improvement in 2020. The U.S. economy remains hampered by an absence of private investment growth and falling productivity, owing to trade uncertainty and rising labor costs. These trends will continue to put downward pressure on already sluggish corporate earnings growth. Monetary stimulus from the Federal Reserve and other central banks has helped, but inflation risks are rising and most central banks have already cut rates close to all-time lows. The U.S. economy has downshifted to 2% from 3% growth over the past year, mirroring the slowing global expansion. We expect neither a sharp acceleration nor a further slowdown in 2020. Rather, we see another year of around 2% growth as the likeliest outcome.
China’s economic stimulus has not produced the same massive credit growth that fueled global cyclical upturns in prior years (Figure 1). Retail sales and investment have also weakened by more than expected, and China’s growth rate seems likely to fall below 6% next year for the first time in recorded history. Europe’s open economy remains hostage to weak overseas demand, particularly for manufactured goods. While Germany has narrowly avoided recession, signs of genuine recovery on the continent remain few and far between, leading us to expect another sluggish year of just over 1% real growth.
Avoiding the worst-case scenario
If our outlook doesn’t bring cheer, consider that it’s already brighter than what we were bracing for just a few months ago: A trade war on a rolling boil, a Brexit mess and a worrying weakness in economic data headlined the global narrative coming out of the summer. Since then, however, U.S. consumers have shown resilience and the U.S. labor market has strengthened. Against the prevailing demographic trend placing more Americans into retirement (or, at least, retirement age), overall labor force participation has inched higher and wage growth has remained supportive of future consumption (Figure 2). Lower interest rates have also provided a boost to the housing market. Builders are applying for more permits today than at any point in over a decade.Global manufacturing, while still weak, is climbing out of recession, led by the U.S. and China. Factory inventories have fallen, as manufacturers hold well-founded doubts about whether demand will continue to weaken. But some of the leading indicators within manufacturing surveys have begun to improve. New orders for Chinese manufacturers, a leading indicator for growth, hit their strongest level in October since 2013.
As we look into 2020, financial conditions have crucially become more supportive of growth: Market-based recession risks have gone from flashing orange or red to merely yellowish green. The U.S. Treasury yield curve has steepened — and uninverted — while credit spreads have narrowed and the U.S. dollar has eased down from its decades-high level.
As the outlook brightens, investors may still be overestimating the downside risks, but we still believe global recession risks have abated or, indeed, reversed in recent months. And that belief has tempered our pessimism as well as our appetite for purely defensive assets like cash in our investment strategies.
The path for economic growth looks clearer, but markets will be challenged to match 2019’s performance.
Approaching the 2020s with caution
The 2010s rewarded investors who put their money into broad public market indexes. Global stocks produced close to double-digit average annual returns while global bonds also generated solid results. In both cases, stellar performance has been accompanied by rising valuations, setting up returns to be lower in the 2020s. Valuation is generally a poor predictor of performance in a single calendar year, but it has been the best single predictor of both absolute and relative performance over 10-year periods.
A 50-50 portfolio of the MSCI All Country World Index (global stocks) and the Bloomberg Barclays Global Aggregate Index (global bonds) returned an average of 7.2% per year from November 2009 through October 2019. The average yield on the global bond index at the start of that period was just under 3%, more than double its level today. Similarly, global equities are priced for a lower return in the 2020s than over the past decade, with P/E ratios significantly higher than they were at the start of the decade.
U.S equities have provided the bulk of the returns on the global index over the past 10 years. But based on historical data, their current cyclically adjusted P/E ratio of close to 30 implies an average total return in the mid-single digits over the coming decade (Figure 3). That’s well below half of their average return during the 2010s.
We haven’t reached an equilibrium
We don’t foresee either a heating up or a cooling down of growth in 2020, but that doesn’t mean markets have reached a stable equilibrium. Policy uncertainty has declined, to be sure, but it remains elevated. We know from recent experience that spikes in uncertainty tend to drive investors out of stocks and into bonds and cash, sending the equity risk premium higher (Figure 4).
Even absent new policy risks, the prevailing global economic trend is still for lower growth over time. Trade flows and population growth are declining. Productivity growth in the U.S. has turned negative less than two years after the passage of a tax bill that was meant to spur innovation. Instead, companies are taking fewer risks, as they see their profit margins eroded by rising costs. Firms may eventually have to push these costs onto consumers, leading to higher inflation and the potential for Fed rate hikes to reenter the picture. While we don’t see this scenario playing out in 2020, fears of hikes in 2021 or beyond could have a significant market impact if they are anticipated far in advance.
We also do not believe most asset classes are priced today to produce higher returns in the coming years unless there is a significant improvement in global fundamentals. Credit spreads are narrower, interest rates are lower and equity price-to-earnings multiples are far higher than they were a year ago (Figure 5). And there is no near-term catalyst akin to the 2017 corporate tax cuts to boost earnings. To borrow a phrase from last year’s outlook, we expect a tougher climb for U.S. stocks in the year ahead. Equity markets outside the U.S. may benefit, to the extent they are valued more cheaply, but we see similar barriers to higher profits and stronger investor risk appetite in Europe, Japan or emerging markets.
Wait, there’s a U.S. election coming up?
Somehow we’ve gone this far without addressing the elephant in the room — or the donkey, depending on your political proclivity. In just under a year, the U.S. will hold a presidential election. The unusually high and unusually early amount of interest that voters and investors alike have taken in the outcome is already affecting markets. U.S. health care could be severely disrupted if a single-payer system is enacted in 2021. The fact that several candidates have proposed one may have caused the sector to struggle for much of 2019. Some of the policy proposals on technology, energy and financials could have similar market effects, and some may have already.
The GIC spoke to a number of Nuveen’s sector analysts about the potential impact of federal regulatory policy and legislative changes on their coverage areas. Without exception, they believed that a lot of political risk was already embedded in asset prices across both credit and equity markets. As such, we are not heavily weighting the election in most of our investment strategies for 2020. In addition to examining the impact various policy proposals might have on the economy and financial markets, we also need to factor in the extent to which they are already priced in, as well as the chances that they’ll ultimately be enacted. Who will the presidential candidates be? Who will be president in 2021? What will Congress look like? How will the courts treat various executive actions? All of these questions tend to dilute our expectations for massive policy swings in the coming years. At this stage, it does not make sense to give too much weight to any single outcome.
We are expecting global growth to average just over 3% in 2020, a slight improvement over 2019. We also expect interest rates to remain low and stocks to make fewer new all-time highs. Investors’ search for yield will drag on, supporting the case for fixed income diversification and equity dividend yield and growth. Income-producing alternatives will become a more valuable part of an asset allocation given our expectation that returns on traditional stock and bond portfolios will be lower.
Policy risks remain, and central banks are low on ammunition to confront an unexpected slowdown. But investors who are paralyzed by the U.S. election or other sources of policy uncertainty are likely overestimating the risks. The chances of an escalating trade war or a messy Brexit have fallen, while the help markets are receiving from easier financial conditions may just be kicking in, clearing the path for growth in the year ahead.
The bottom line is that the next decade could be tougher for investors than the last 10 years. But that doesn’t mean we think investors should head to the sidelines. As you’ll see throughout our 2020 Outlook, we’re finding a range of good opportunities across asset classes — as long as they are approached with nimbleness and flexibility.