The Outlook: December 2019 economic commentary
Five questions for global financial markets in 2020
At this time of year, it's customary for investors to look to the year ahead in a bid to determine what is in store for the economy and financial markets. In this month’s commentary, we take a look at some of the issues that could impact global financial markets during the next twelve months.
Will there be a global recession in 2020?
Growth in the global economy slowed during 2019, raising concerns that descent into recession might not be far off. However, in the absence of an escalation of the ongoing trade war, a contraction in the global economy should be avoided in 2020. Recent survey data point to a pick-up in the manufacturing sector, which had led the global slowdown over the previous 18 months or so. Orders have started rising again, setting the stage for firmer activity in 2020. Robust labour markets have continued to underpin consumer spending.
This year’s interest rate cuts from the US Federal Reserve and other central banks have led to a loosening in financial conditions which should support activity in 2020. Against the backdrop of below-target inflation in developed market economies, we are unlikely to see significant monetary tightening from the major central banks. As a result, real interest rates (i.e. adjusted for inflation) should remain below levels that typically trigger recessions.
This said, even if the US and China manage to sign an interim ‘phase one’ trade deal, ongoing uncertainty regarding the global trading environment and ‘de-globalisation’ will continue to weigh on business confidence and capital expenditure. This suggests that a marked reacceleration in growth similar to that seen in 2017 is probably not on the cards.
Will fiscal stimulus provide a big boost to the global economy in 2020?
Several major economies are likely to see fiscal policy loosened next year. As we noted in our November commentary, government spending seems set to increase in the UK whoever wins the 12 December election. In Japan, the government has recently announced a ¥13 trillion stimulus package. However, it is not clear how much of this will actually represent new spending. Moreover, there is a concern that the package will be insufficient to lift the economy, given the fallout from the recent consumption tax hike and the expectation that activity will fall back once the Tokyo Summer 2020 Olympics are over.
Given its prevailing budget surplus and relatively low public sector debt levels, Germany is well placed to provide fiscal stimulus. Current budget plans suggest Europe’s biggest economy is on course for a modest fiscal easing of around 0.4% of GDP. However, political and cultural factors suggest a big spending splurge is not on the cards (see our March 2019 commentary).
In the US, the boost from President Trump’s 2018 tax cuts will fade further in 2020 and, given a divided Congress, there is little prospect of renewed giveaways ahead of the November 2020 presidential election. In China, the authorities appear ready to provide enough stimulus to stabilise GDP growth around the 6% mark. However, concerns over rising debt levels and a desire to rebalance the economy suggest a large stimulus package like that introduced in the wake of the global financial crisis is unlikely to be forthcoming. The absence of aggressive easing in the US and China – the world’s two largest economies - suggests that hopes for a big boost to global activity from looser fiscal policy are probably misplaced.
Will corporate profits bounce back in 2020?
2019 will not be remembered as a great year for corporate profits growth. Slowing global trade, weak commodity prices and inverted/flat yield curves have weighed on profitability this year. In the US, where S&P500 earnings fell 2% year-on-year in the third quarter, these headwinds were compounded by the strength of the US dollar. At the global level, recent estimates suggest earnings were broadly flat in 2019.
For 2020, the consensus forecast is for a near 10% rise in global corporate profits. This looks optimistic given the prospect of only lacklustre global growth and the potential for rising wages to squeeze margins. Historically low levels of unemployment in much of the developed world is putting upward pressure on labour costs, threatening to crimp profits. In the US, the profit share of GDP has fallen back in recent years, albeit from historically high levels. On the plus side, firmer commodity/oil prices on the back of stabilisation in industrial activity and recent OPEC production cuts could herald a better year for earnings in the materials/energy sectors. However, overall it would not be surprising to see global earnings expectations revised down during the course of 2020.
Will the US Federal Reserve change its policy framework in 2020?
A key event for 2020 will be the conclusion of the Fed’s policy review. With inflation having consistently come in below the Fed’s 2% inflation target in recent years, reports suggest that the Fed is considering a new framework under which it would foster a period of above-target inflation to compensate for earlier undershoots. The aim of this so-called ‘make-up strategy’ would be to prevent below-target inflation from becoming entrenched. (If a period of below-target inflation results in consumers and businesses revising down their expectations of inflation, this can lead to a self-fulfilling prophecy of low inflation via the effect on wage negotiations and spending decisions.)
Such a change in policy could have significant repercussions for financial markets. A credible commitment to an ‘inflation make-up strategy’ would involve the central bank leaving interest rates lower for longer, even amidst nascent signs of an upswing in growth and rising inflation pressures. This suggests that ‘real’ (i.e. adjusted for inflation) interest rates would fall. In addition, the reduced risk of a potentially damaging period of deflation and the prospect of higher average inflation would increase inflation expectations. The combination of lower ‘real’ bond yields and higher inflation expectations could potentially increase the relative attractiveness of risk assets, such as equities.
How might the US presidential election in November 2020 impact markets?
Historically, US equities (which make up around 56% of the MSCI All-Country World Equity Index) have tended to do well during the year leading up to a presidential election. According to JP Morgan, the S&P500 has returned nearly 10% on average during the 12 months prior to the last 20 US presidential elections. President Trump clearly has an incentive to maintain economic growth, keep unemployment low and ideally oversee new record highs in the stock market during the run-up to the election. With little room for manoeuvre regarding fiscal policy, this might equate to a ‘do no harm’ policy, which would argue against an escalation of the trade war.
However, the campaign could still prove disruptive to markets. If the Democrats select a left-wing nominee (e.g. Elizabeth Warren or Bernie Sanders) and President Trump’s approval rating is hit by ongoing impeachment proceedings, markets could start to worry about a less business-friendly tax and regulatory environment under a future Democratic president (see our October 2019 commentary). In recent weeks Elizabeth Warren has fallen back in the polls and betting markets currently see Joe Biden (a more market-friendly candidate) as a favourite, but the situation could change.
Conversely, a second term for President Trump might not be great for markets either. Although political expediency might usher in a more conciliatory approach towards China during the election campaign, a second Trump term could see an emboldened president adopt a more confrontational stance on trade. Faced with such a prospect, market volatility could increase ahead of the election and political uncertainty could make it difficult for US equities to continue their run of outperformance seen since the financial crisis.
This article is for generic information only and is not suggesting a suitable investment strategy for you. You should seek independent financial advice that takes your individual circumstances into account prior to proceeding with any course of action.