We think 2020 will be characterised by muted global growth, a slowing US economy and continued uncertainty about how monetary policy and politics will move markets.
Central banks will keep using the policy levers at their disposal to try to spark economic growth, but we question how much room they have for manoeuvre. Interest rates have been negative in Japan and Europe for some time, and the US Federal Reserve has resumed cutting rates that were already low. Yet while this accommodative environment has supported equities and other financial assets, it has not restored enough growth or confidence. Facing a dwindling number of options, central banks will likely continue “pushing on a string” – offering additional stimulus with limited effect. More fiscal spending from governments may be needed.
One notable trend in 2019 was the marked deterioration of US dollar liquidity, caused by the Fed reducing the size of its balance sheet via quantitative tightening. With the dollar attracting 88% of all foreign-exchange transactions, according to the Bank for International Settlements, demand for dollars exceeds what the reserves of the US banking system can support. If dollar illiquidity spikes, it would severely impair financial flows and investment. We will be watching to see if the dollar’s status worsens again in 2020, given that the Fed is now temporarily increasing bank reserves by extending its overnight “repo” funding operations. The dollar is experiencing other tensions as well: central banks outside of the US don’t want their currencies to appreciate against the dollar, while US President Donald Trump wants a weaker dollar to boost exports.
Speaking of Mr Trump, all eyes will be on the 2020 US presidential elections – the outcome of which will have major ramifications for the US markets and politics for the next decade. If Mr Trump survives his impending impeachment and wins re-election, we expect the status quo for the markets. If the Democrats win the presidency, we expect valuations and earnings to fall, given that some of their leading candidates’ policies specifically target corporate profitability and taxation. Importantly, the health of the US economy has historically been one of the biggest factors in how people vote in presidential elections, and the economy has already been slowing as the impact of President Trump’s fiscal stimulus package fades. We expect the US economy to fall into a recession by the end of 2020 – perhaps just as voters are heading to the polls.
We also expect global economic growth to be dull, driven mainly by the slowdown in China. This is creating demand issues for major exporters such as Germany, Japan and South Korea – which are all hoping for trade-related tensions to settle back down. But regardless of how the US-China trade war gets resolved, it has already contributed to the growth of two competing tech ecosystems – one American, one Chinese. Companies and countries may need to choose which ecosystem to use in this “tech cold war”. This may further interfere with the supply chains of global tech companies, many of which face renewed regulatory scrutiny. Consider the mounting pushback against Big Tech firms that stand accused of not paying their share of taxes, misusing personal data and enabling social instability. We expect the European Union and the US to regulate and tax some of these mega-companies, which could impact their already-high valuations.
Other themes to watch in 2020 include oil and food security. While oil prices have been relatively stable this year – hovering mostly in the USD 50-70 per barrel range – rising geopolitical tensions in the Middle East could pressure the oil supply. At the same time, climate change is pushing more investors away from fossil fuels, providing the industry with less capital for growth and investment. The food-supply chain is also more vulnerable than many realise to trade tensions, abnormal weather patterns and disease outbreaks. Food-price inflation is one of the more serious “flations”: in some instances, it slows economic growth through wage inflation; in the most serious cases, it endangers lives.
A resolution to the Brexit drama may be positive not just for European investors, but for those further afield who have avoided the region amid long-running uncertainty. Further delays in resolving Brexit would likely hurt the UK economy and turn the British pound weaker and more volatile. Such economic damage would damage major exporters, such as Germany and its car sector. But if the UK sorts out Brexit in 2020, UK markets could rebound as pent-up investment is released. This may be positive for international sentiment around European assets overall, though some investors may already feel they’ve allocated enough to Europe.
Europe faces a challenging year ahead. There will be plenty of political headlines to navigate – particularly in Spain, Italy and Germany – and core EU countries are growing anxious about negative interest rates and additional quantitative easing. Faced with negative yields, European investors will need to hunt for income elsewhere – perhaps in the US or Asia – and consider unloved but high-yielding international equities. Markets should continue their “risk-on/risk-off” trades – moving toward higher-risk investment when economic and policy indicators improve, and toward safer investments when they fall. As a result, standard beta market returns will likely continue to be volatile. We advise taking an active approach to investing, carefully choosing positions in highly valued markets – perhaps US equities – while also considering contrarian ideas such as European equities, gold, oil and emerging-market debt.