As a new decade begins, our “glass half-full” assessment continues
The new year marks a new decade, and 2020 promises significant developments. A U.S. Presidential election, ongoing British exit deliberations and United States/China trade negotiations permeate debates about how long the current economic cycle can persist. For investors, 2019 represented gains across most major asset classes following a challenging 2018, and many are questioning whether momentum can persist.
We see a global economy forming a solid base in early 2020, thanks to consumers who are employed and spending and decent corporate profit trends, yet ongoing growth is susceptible to major policy risks. Trade policy is the most immediate issue, with some businesses awaiting clarity before initiating major capital expenses, and rumblings surrounding impeachment add to conjecture. We expect central bank policy to continually reflect an accommodative and pro-growth stance, adding to our glass half-full perspective on the economy and markets.
Of course, markets do not always move in lockstep with the global economy. Strong asset returns in 2019 may have pulled forward anticipated stabilizing and improving economic trends. Within global equities, we favor domestic stocks due to reasonable profit growth expectations and favorable valuations. International developed equities may continue the strength reflected in the second half of 2019, despite long-term demographic challenges, and emerging market stocks will follow China’s lead. We are not expecting a blockbuster total return environment for bonds but expect investors will continue to enjoy the defensive properties high-quality government and corporate bonds provide. However, we are watching for any signs of credit deterioration. Real assets may also show some resurgence if inflation returns beyond our expectation of a modest pickup in the first half of 2020, and we continue to recommend that qualified investors explore hedge fund and private market strategies if they’re suitable for their unique situations. In sum, we anticipate a confluence of strong consumers, measured corporate profit growth at reasonable valuations and a global economy grinding out a reasonable output level to produce modest total portfolio gains for diversified investors. The potential for an even better year exists if policy risks remain at bay.
Global economic views
Policy adjustments from 2019 will likely stabilize global economic growth and lift inflation prospects, at least for the first half of the year. Government policy will be a key factor in the magnitude and direction of these changes. Policy risks skew slightly toward the United States in 2020 as we head into the Presidential election. Political headwinds, outside of trade issues with the U.S., seem to have abated in many foreign economies.
Restrained inflation, low interest rates and moderate earnings growth provide valuation support and the basis for U.S. stocks to trend higher in the new year. Additionally, the dividend yield of U.S. equities remains attractive compared to lower-yielding fixed income alternatives. Investor sentiment is mostly positive, evidenced by strong performance and attractive valuations, helping shape expectations for still higher equity prices. As we close 2019, valuations are elevated compared to historical norms, yet remain short of extreme levels.
Reasonable profit growth, combined with a 3.5 percent dividend yield, forms the basis for our positive, but more subdued, outlook for foreign developed equities in 2020. Investor sentiment also remains favorable. Valuation measures are reasonable and trending higher, indicative of rising investor optimism. We remain cautious due to structurally low economic potential, a lack of fiscal policy cohesion, a continued uptrend in the U.S. dollar and the composition of indices compared to domestic equity indices.
Achievable double-digit profit growth, combined with a 2.9 percent dividend yield, leads to our outlook for balanced, but improving, emerging market equities in 2020. The improvement in our emerging markets economic Health Check supports expectations of a recovery of corporate profits in 2020, but we’ll view a recovery with some skepticism until it comes more clearly into focus. Valuation based on forward-looking earnings estimates is well above long-term averages, suggesting that investors may have already adjusted market prices, a risk for earnings disappointments in the year ahead.
Fixed income markets
Long-term rates should remain rangebound near all-time lows in 2020, but three factors could drive rates modestly higher: Heavy Treasury issuance due to deficit spending, extremely low government bond yields outside the United States and progress in U.S. trade talks that could alleviate investor safe haven demand for U.S Treasuries.
In 2020, interest rate cuts are unlikely to surpass the pace of the third quarter, but central banks globally are likely to maintain an easing bias. This should act as an incremental tailwind to risk assets and inflationary pressures. Domestically, the Fed appears to be on hold for now after three rate cuts in 2019. Global central bank balance sheets are growing again, with asset purchase programs resuming. Ongoing bond purchases should help keep shorter-term bond yields contained and continue to lend support to risk assets.
Property market fundamentals are now more mixed. Vacancy rates are near historic lows, but net operating income (NOI) growth slowed and is currently below the long-term average. (NOI is the revenue from property minus operating expenses.) Additionally, income (as measured by NOI) relative to property values is near all-time low levels, indicating prices are high. While the deceleration in NOI growth is urging caution, we believe investors are still likely to at least earn the dividend yield of real estate investments. We remain cautious, with the understanding that changes in interest rates can have an outsized impact on property market performance going forward.
Investor sentiment remains favorable across alternative investments, with a large majority of investors planning to commit the same or more capital in the year ahead. Hedge fund performance was positive and broad based in 2019. The best-performing strategies focused on the Technology and Healthcare sectors, which remain attractive opportunities into 2020. Private investment fund returns are likely to remain solid when compared to public market but more modest relative to history. Investors should concentrate on private markets funds that offer “value-add” knowledge in addition to the capital invested in a company. Knowledge and experience are competitive advantages that can assist the fund’s portfolio of companies, renegotiate contracts to reduce costs, increase market share, improve the use of technology and find a strategic buyer.
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This commentary was prepared December 2019 and represents the opinion of U.S. Bank Wealth Management. The views are subject to change at any time based on market or other conditions and are not intended to be a forecast of future events or guarantee of future results and is not intended to provide specific advice or to be construed as an offering of securities or recommendation to invest. Not for use as a primary basis of investment decisions. Not to be construed to meet the needs of any particular investor. Not a representation or solicitation or an offer to sell/buy any security. Investors should consult with their investment professional for advice concerning their particular situation. The factual information provided has been obtained from sources believed to be reliable but is not guaranteed as to accuracy or completeness. Any organizations mentioned in this commentary are not affiliated or associated with U.S. Bank or U.S. Bancorp Investments in any way.
Diversification and asset allocation do not guarantee returns or protect against losses. Based on our strategic approach to creating diversified portfolios, guidelines are in place concerning the construction of portfolios and how investments should be allocated to specific asset classes based on client goals, objectives and tolerance for risk. Not all recommended asset classes will be suitable for every portfolio.
Past performance is no guarantee of future results. All performance data, while deemed obtained from reliable sources, are not guaranteed for accuracy. Indexes shown are unmanaged and are not available for investment.
Equity securities are subject to stock market fluctuations that occur in response to economic and business developments. International investing involves special risks, including foreign taxation, currency risks, risks associated with possible difference in financial standards and other risks associated with future political and economic developments. Investing in emerging markets may involve greater risks than investing in more developed countries. In addition, concentration of investments in a single region may result in greater volatility. Investing in fixed income securities are subject to various risks, including changes in interest rates, credit quality, market valuations, liquidity, prepayments, early redemption, corporate events, tax ramifications, and other factors. Investment in debt securities typically decrease in value when interest rates rise. The risk is usually greater for longer-term debt securities. Investments in lower-rated and non-rated securities present a greater risk of loss to principal and interest than higher-rated securities. There are special risks associated with investments in real assets such as commodities and real estate securities. For commodities, risks may include market price fluctuations, regulatory changes, interest rate changes, credit risk, economic changes and the impact of adverse political or financial factors. Investments in real estate securities can be subject to fluctuations in the value of the underlying properties, the effect of economic conditions on real estate values, changes in interest rates and risks related to renting properties (such as rental defaults). Hedge funds are speculative and involve a high degree of risk. An investment in a hedge fund involves a substantially more complicated set of risk factors than traditional investments in stocks or bonds, including the risks of using derivatives, leverage and short sales, which can magnify potential losses or gains. Restrictions exist on the ability to redeem or transfer interests in a fund. Private capital investment funds are speculative and involve a higher degree of risk. These investments usually involve a substantially more complicated set of investment strategies than traditional investments in stocks or bonds, including the risks of using derivatives, leverage, and short sales, which can magnify potential losses or gains. Always refer to a Fund’s most current offering documents for a more thorough discussion of risks and other specific characteristics associated with investing in private capital and impact investment funds. Private equity investments provide investors and funds the potential to invest directly into private companies or participate in buyouts of public companies that result in a delisting of the public equity. Investors considering an investment in private equity must be fully aware that these investments are illiquid by nature, typically represent a long-term binding commitment and are not readily marketable. The valuation procedures for these holdings are often subjective in nature. Private debt investments may be either direct or indirect and are subject to significant risks, including the possibility of default, limited liquidity and the infrequent availability of independent credit ratings for private companies.
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