As we enter 2020, markets have priced in a substantial amount of favorable news, including global central bank easing and quantitative easing, a potential bottoming in economic data and some thawing of geopolitical risks.
However, the backdrop remains benign for risk assets with low growth, rates and inflation, which can support a modest upside in 2020.
Nonetheless, given the rally we have seen year-to-date, markets continue to remain vulnerable to corrections and volatility in the near term and will be driven largely by economic data and politics in the year ahead, here are a couple of themes for investors to watch for in 2020:
US economy: Will hope of recovery become a reality?
The market narrative shifted in the last two quarters of 2019 – from one of extreme pessimism and fear of an imminent recession, to one of economic stability and a potential mid-cycle refresh. This shift caused a notable rotation in equity markets – from defensive “recession-proof” sectors such as real estate, utilities and consumer staples, to more cyclical “pro-growth” sectors such as financials and industrials.
We may now see a period of consolidation as investors wait for confirmation from economic data before calling the next leg in risk assets.
The United States and other major economies may be going through a bottoming process for the next quarter or two. However, the economy remains vulnerable to shocks and the upside potential in a growth rebound remains modest at best. We will continue to see US economic growth softening in 2020, but the probability of a near-term recession remains low.
Despite the US Federal Reserve indicating that its mid-cycle adjustment is essentially completed, markets are pricing in one or two more rate cuts in 2020. In other words, the market’s rate-cutting expectations could become a source of disappointment.
For S&P 500 earnings, we believe the current consensus of a 9.7 percent earnings growth in 2020 is high, after a near-zero earnings growth in 2019. We instead see a low or mid-single-digit earnings growth as more feasible, particularly if the American economy stabilizes.
This profit growth could lead to low or mid-single-digit S&P 500 returns in 2020, assuming a constant price-to-earnings multiple.
US elections: Impact on healthcare sector
The November 2020 US presidential election could be a key market-moving event. Proposed policy changes could affect several sectors, including technology, energy and financials, but perhaps the sector that has suffered most is healthcare. The healthcare sector has underperformed in 2019, becoming the second worst performing sector in the S&P 500 Index, behind energy.
We believe investor fears about potential Democratic policies on healthcare are likely overdone and may provide an opportunity in 2020. A new proposal by any of the candidates will first have to overcome the legislative hurdle of a likely split Congress and then will take time – years in many cases – to implement.
We look to the lagging healthcare sector for potential opportunities, particularly in the areas of biotechnology and the use of healthcare-focused artificial intelligence (AI) and robotics – both long-term secular themes.
Implications for investors
We believe investors should allocate more to global equities in 2020. If we continue to see global economic data stabilize and geopolitical overhangs such as US-China trade tensions and Brexit improve, global equities may have more upside potential than US equities, given their relative underperformance this year.
European and Asian equities may also offer more favorable dividend yields for those hunting for yield, as would selective emerging market assets in equities and fixed income, particularly if the US dollar stabilizes or softens. As regards US equities, given the robust returns in 2019, we remain neutral in the near term and continue to favor a barbell approach from a sector perspective.
We believe disruptive technology themes such as AI, mobile payments and cybersecurity have secular growth stories behind them, particularly in a low-growth and low-rate environment. We also look to continue to see a rotation out of defensives and into cyclical sectors. We favor financials and industrials, and believe healthcare could rebound in 2020.
On the other hand, credit has rallied substantially this year globally in the face of accommodative monetary policy and muted inflation, and these conditions are unlikely to repeat at the same scale in 2020. Our preference remains for US investment-grade and selective high-yield bonds, given the view that a near-term recession or default cycle is unlikely.
Lastly, we see ESG investments becoming a more meaningful part of investor portfolios, as we are in the early stages of growth in environmental and global sustainability industries.
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