What to Watch in 2020 - RONALD TEMPLE, CFA, Co-Head of Multi-Asset and Head of US Equity DAVID ALCALY, CFA, Research Analyst - Lazard Asset Management
←
→
Page content transcription
If your browser does not render page correctly, please read the page content below
What to Watch in 2020 RONALD TEMPLE, CFA, Co-Head of Multi-Asset and Head of US Equity DAVID ALCALY, CFA, Research Analyst
What to Watch in 2020 Market Performance
Slowing growth never feels good. In 2019, global LEVEL YTD 2019 2018
real GDP growth will likely decelerate from 3.6% US Equities
S&P 500 6,283 26.0% -4.4%
in 2018 to just above 3%.1 The slowdown was most
Russell 3000 9,714 25.6% -5.2%
concentrated in industrial and trade-exposed sectors Russell 2000 7,994 18.9% -11.0%
and economies, with the US-China trade war and
MSCI Regional Indices
a meaningful decline in auto demand weighing
AC World 1,326 22.3% -7.2%
particularly heavily on activity. In spite of the third
US 13,047 26.3% -4.5%
industrial down-cycle in the last decade, service- and Europe ex-UK 7,468 24.6% -10.6%
consumer-exposed sectors largely remained resilient. In UK 16,020 11.7% -8.8%
the US in particular, household finances continued to Pacific ex-Japan 10,865 16.5% -4.4%
improve on the back of labor market strength. Japan 2,302 16.6% -14.9%
EM 134,964 12.3% -9.7%
Political concerns continued to cloud the economic
Fixed Income
outlook as US protectionism escalated substantially, US 10Y Yield 1.77 -92 bps +25 bps
Brexit uncertainty persisted, European political frag- Germany 10Y Yield -0.33 -57 bps -23 bps
mentation continued, and impeachment proceedings Japan 10Y Yield -0.12 -11 bps -5 bps
against US President Donald Trump began. Moody’s BAA Spread 212 bps -33 bps +72 bps
US 10Y-3M Spread 21 bps -3 bps -81 bps
Central bankers did their best to stimulate growth.
Other
The Federal Reserve completed its U-turn on
Trade-Weighted USD* 129.79 1.4% 7.5%
monetary policy and unwound three of the four Oil (Brent) Spot $63.96 +$13.39 -$2.77
rate hikes from 2018. The European Central Bank Gold Spot $1,463.90 14.2% -1.6%
(ECB) took rates further into negative territory with VIX 13.13 -48.3% 130.3%
the first rate cut since 2016, bringing the deposit
facility rate to -50 basis points (bps). Both the Fed As of 21 November 2019
Equity market returns are gross local currency total returns.
and the ECB also resumed asset purchases—the The performance quoted represents past performance. Past performance is not a
Fed for technical reasons and the ECB for stimulus. reliable indicator of future results. This information is for illustrative purposes only
and does not represent the performance of any product or strategy managed by
The People’s Bank of China (PBoC) continued Lazard. It is not possible to invest directly in an index.
* As of 15 November 2019. Nominal, broad definition, Jan-1997=100.
to add liquidity to the banking system on the Source: FactSet, Federal Reserve, Haver Analytics
margin, cutting reserve requirements but keeping
benchmark rates largely unchanged. The key question for 2020 is whether 2019’s industrial
Central bank stimulus drove financial asset values deceleration is yet another replay of the slowdowns
higher. Global bond yields declined sharply, and we saw in 2012–2013 and 2015–2016. While there are
after a climactic run in late August, more than $17 hopes for an industrial rebound, they have yet to be
trillion in debt was in negative-yield territory. At realized, and continued buoyancy in the service sector
the same time, equity markets powered higher, with is not guaranteed. Looking ahead, our base case
the S&P 500 Index reaching a new record high over expectation is that consumers will remain resilient
3,100 and the MSCI AC World ex USA Index rising and that the US and most other major economies will
by more than 15%. avert recession—or a “hard landing”—in 2020. In the
year ahead, we will be watching six key issues.
21. Trade Tensions • Bear case: Negotiations break down and the es-
In 2019, US protectionism—and Chinese calation in tariffs continues, with the US imposing
retaliation—escalated substantially (Exhibit 1). Both the tariffs originally scheduled for 15 October and
the direct impact of tariffs and the larger impact 15 December, and China retaliating.
of uncertainty on business investment became We view resolution of the broader dispute as
increasingly evident. As pressure mounted, US and highly unlikely given that certain aspects of the
Chinese negotiators signaled in the fourth quarter that US’ complaints are likely non-negotiable, including
they were nearing a “phase one” trade deal that still demands that China fundamentally change its
needed to be formalized. economic system by dismantling its industrial
policies. Moreover, with the increasingly prominent
We continue to believe the overall trajectory for view in Washington that China has become a
US-China trade tensions is negative—two steps strategic adversary, it is highly likely that the US will
backward, one step forward—and that the political continue to roll out targeted measures that restrict
space for any deal is very narrow. That said, we see US companies from selling sophisticated technology
three broad scenarios facing investors on US-China products and services to Chinese clients.
trade in 2020:
Moving beyond China, the US also has fractured its
• Bull case: Tariffs are partially rolled back and trading relationships with a range of other parties.
China agrees to purchase more US commodities. We see the most elevated risk being the US trade
• Base case: The escalation in tariffs pauses, but tariffs relationship with the European Union, where the
already imposed remain in place at current levels. US has most recently threatened tariffs on the
automobile and auto parts industries.
Exhibit 1: New US Tariffs Only Began to Bite Recently
Average Tariff Rate on US Imports from China
(%)
Indefinitely
28 Delayed on
11 October 2019
Existing Tariffs (2017 and before) Other Tariffs China-Specific Tariffs
21
14
7
0
2017 2018 a 10 May 2019 b 1 September 2019 c 15 October 2019d 15 December 2019 e
(planned) (planned)
As of 23 August 2019
“Lists” refer to lists of products released by USTR. d. 15 October 2019: Hike to 30% on Lists 1−3 ($250bn)
a. 2018: 25% on List 1 ($16bn), 25% on List 2 ($34bn), and 10% on List 3 ($200bn) e. 15 December 2019: 15% on List 4B ($160bn).
b. 10 May 2019: Tariff hike to 25% on List 3 ($200bn) Anticipated total impact: 96.8% of US imports from China
c. 1 September 2019: 15% on List 4A ($112bn)
Source: Peterson Institute for International Economics
32. Global Industrial Inflection
Exhibit 2: The Slowdown Has Been Concentrated in
Global industrial production and trade began slowing Industrial Sectors
in 2018 and decelerated even more acutely in 2019,
Global Industrial Production, Trade, and Manufacturing
with weakness in motor vehicle manufacturing Purchasing Managers’ Indices
(Exhibit 2) potentially accounting for as much as
a third of the 2018 slowdown in trade, by IMF YoY Change (%), 3-month moving average
6
estimates.2
4
Late in 2019, we have begun to see survey data,
such as the Purchasing Managers Indices for the 2
manufacturing sector, stabilize and even start to
rebound on the margin (Exhibit 3). Part of the 0
Industrial Production Trade Volume
stabilization may reflect improving sentiment due to Manufacturing PMI*
-2
the potential for a pause in the US-China trade war, 2015 2016 2017 2018 2019
but in our view, the bigger driver is that sentiment
Sales and Registrations in G7 and China
simply overshot on the downside relative to the reality
of the manufacturing economy. YoY Change (%), 3-month moving average
10
To the extent the US and China do reach an agreement,
5
we would expect uncertainty in the business sector to
subside somewhat and broader sentiment to improve 0
further. The inflection in industrial activity is especially
important to Europe, and particularly to Germany, -5
which saw its economy contract in the second quarter
after years of powering the euro zone economy. The -10
2015 2016 2017 2018 2019
rest of the euro zone has proven more resilient, as
* Deviations from 50 for Manufacturing PMI
France and Spain depend less on industrial activity and
Industrial production as of August 2019. Trade volume as of August 2019. Vehi-
exports to drive growth. Moving into 2020, it will be cle sales/registrations as of October 2019 (Canada as of August 2019)
important for industrial growth to at least stabilize in Source: Association des Constructeurs Européens d’Automobiles, China
Association of Automobile Manufacturers, Haver Analytics, IMF, Japan Auto
order to avoid dragging down the service economy. Dealers, JP Morgan/IHS Markit, Netherlands Bureau for Economic Policy
Analysis, Statistics Canada, US Bureau of Economic Analysis
Exhibit 3: Service Industries Have Held Up Better
Global Manufacturing and Service PMIs
Index
55
Manufacturing PMI Service PMI
54
53
52
51
Expansion
50
Contraction
49
2015 2016 2017 2018 2019
As of October 2019
Source: Haver Analytics, JP Morgan/IHS Markit
43. US Labor Markets Through 2019, job growth decelerated (Exhibit 5)
The strength of the US labor market, and its ability but remained at a level materially above that needed
to drive wage growth, has been a key premise for to keep pace with population growth. In 2020, we
our optimism regarding the US economy for the expect further slowing in the job growth numbers as
last several years (Exhibit 4). We believe there is employers find it more difficult to fill open positions
a virtuous circle in which stronger labor markets and global growth remains sluggish.
lead to higher wage growth, which in turn leads to Compounding the evidence of a slowing labor
increased consumer spending, which then feeds back market is a decline in the job opening rate from
into job and wage growth.
Exhibit 4: US Wage Growth Continues Grinding Higher
Average of Three Common Wage Measures
YoY Change (%)
5
Atlanta Fed Wage Growth Tracker Average Hourly Earnings
Employment Cost Index Average
4
3
2
1
2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
As of October 2019. Atlanta Fed Wage Growth Tracker as of October 2019. Employment Cost Index as of September 2019. Average as of September 2019
Average Hourly Earnings are for production and nonsupervisory workers. The Atlanta Fed Wage Growth Tracker is the smoothed weighted overall wage growth tracker,
which is reweighted to reflect the demographics of wage earners. Employment Cost Index (ECI) is for wages & salaries of civilian workers excluding incentive-paid
occupations. The ECI is a disaggregated quarterly series.
Source: Bureau of Labor Statistics, Federal Reserve Bank of Atlanta, Haver Analytics
Exhibit 5: US Employment Growth Has Slowed
Average Monthly Change in Private Nonfarm Payrolls
(Thousands)
250 240
215
200 187 197
176 172 183
146 151 154
150
123
100
50
0
2012 2013 2014 2015 2016 2017 2018* 1Q 2019* 2Q 2019 3Q 2019 October 2019
3-Month
Average
As of October 2019
* Indicates that the monthly average change in private nonfarm payrolls has been adjusted for the Bureau of Labor Statistics’ preliminary estimate of its upcoming annual
benchmark revision to the establishment survey employment series. Adjustment has been evenly applied to each month from April 2018−March 2019.
Source: Bureau of Labor Statistics, Haver Analytics
5a high of 4.8% at the beginning of 2019 to 4.4% 5. Global Technology Ecosystem
as of September. Still, our base case is that job While the technology juggernaut has dominated markets
growth will continue to exceed the number of for the last decade, technology companies increasingly
jobs needed to maintain stable unemployment— find themselves in policymakers’ crosshairs. Concerns
about 80−100,000 jobs per month—dragging the over data privacy, global taxation, market power and
unemployment rate below 3.5% and continuing to competition, content moderation, and the role of social
put upward pressure on wages. media in politics all increasingly arouse passion and raise
4. Monetary Policy questions about the public interest.
For perhaps the first time in a decade, 2020 might At the same time, US national security concerns are
be a year in which monetary policy is not a key increasingly leading to restrictions on Chinese access to
consideration. We expect central banks to remain technology. To date, these limitations have been narrowly
on the sidelines for the foreseeable future. Federal defined, but there is scope for them to broaden. And
Reserve Open Market Committee (FOMC) Chair even if they don’t, it is clear that many companies in the
Jerome Powell made it clear in the 30 October press sector are rethinking their supply chains.
conference that the Committee has no intention of
either cutting rates beyond the current level of Compounding these concerns is the fact that China
1.5%−1.75%, barring a significant change in the increasingly is motivated to accelerate and broaden
economic outlook, or of raising them, barring a the scope of its efforts to develop a sophisticated
significant and sustained increase in inflation. indigenous technology industry that is not susceptible
to US trade restrictions. How national competition
We believe this guidance, as does the market in these areas plays out is likely to have far-reaching
(Exhibit 6). Fed funds futures now imply one global consequences in several areas, including the
additional 25-bp rate cut by the fourth quarter of development of global standards in the telecom arena.
2020, likely reflecting the view—which we share—that
there is more downside risk to growth than upside risk Taking all of these factors together, the operating
to inflation. Market expectations for a number of other landscape for technology companies appears to be
major central banks, such as the ECB, imply a similar much less certain than in the past.
outlook, which we feel is directionally appropriate: that
rates are likely to remain on hold through 2020 with
some downside risk. Exhibit 6: Markets “Believe” the Fed
Projected Fed Funds Rate
However, several major central banks may reexamine
their strategies in light of the challenges posed by (%)
3
low rates, low inflation and slow growth. The Fed
is likely to finish a review of its strategy, tools, and
communications in mid-2020, and the ECB could 2
undertake a similar exercise. We expect any shift in
strategy to be communicated carefully, to mitigate the 1
risk of a market surprise. The results nonetheless will Most Dovish FOMC Projection
Median FOMC Projection
be important to understanding what central banks Implied by Fed Funds Futures
might do in the next recession. 0
Dec Dec Dec Longer
2019 2020 2021 Run
Most Dovish FOMC Projection as of 18 September 2019. Median FOMC
Projection as of 18 September 2019. Implied by Fed Funds Futures as of 13
November 2019.
Source: Bloomberg, Federal Reserve
66. US Politics very good trade for an investor who thinks rates
Finally, it would be negligent not to mention will decline by 50 bps, as profit on the trade would
the uncertainty resulting from both the ongoing be the duration multiplied by 0.5%. However, if
impeachment process and US elections in 2020. While rates back up by 100 bps, the same investor would
undoubtedly important events, we believe investors incur large losses.
tend to overestimate the importance of the president The reason we highlight this divergence between
and policy to the overall trajectory of the US economy. long-term investing and short-term trading is that
Furthermore, it is easy to overestimate the likelihood the current market environment poses particularly
of large policy changes. Major changes usually difficult decisions to capital allocators. Rates are
require single-party control of the White House, likely to stay lower than expected for longer than
Senate, and House of Representatives, and they are investors expected even one year ago. As a result,
difficult to predict, as public policy does not operate we believe managers will feel pressure to extend
in a vacuum. The policy areas that we believe should duration and take on more credit risk for higher
be most important to investors in the near term are: yield. This trade may work for a few months or
even a year or more. However, we believe the risk-
• Trade policy, for which the president has significant reward of extending duration is asymmetrically
flexibility to enact change individually; negative at current rates. Moreover, we see
• Corporate tax policy, as a single-seat majority in increasing signs of underwriting sloppiness in the
both houses of Congress is sufficient to make US corporate credit universe.
major changes; Looking through the year, our base case view is
• Regulation of industries such as energy, which the that the US 10-year yield stays in a range of
executive branch can direct in many instances. 1.25%−2.25%. A break above 2.25% is most likely
Many other major policy changes would likely if the US and China resolve a meaningful portion of
require a single party to win a majority in the House, the trade dispute, but this is a questionable scenario.
a filibuster-proof majority in the Senate, and the A breakdown of trade talks amid further escalation
presidency. that leads to weakness in the service sector of the
US economy could easily take the global stock of
Investment Implications negative-yielding debt to $20 trillion and US 10-year
yields below 1.25%.
Given our expectation for slow growth, but no
recession, and extremely accommodative monetary Given our view of rates and credit, it should be
policy, we have a moderately positive near-term no surprise that we are more bullish on equities.
view of financial assets, although we recognize that However, we believe the easy money of 2019 is
the risk of an unexpected shock is always present. behind us and expect a slow grind higher driven by
earnings growth rather than valuation expansion.
The challenge investors face at this point in As we survey global equity markets, no major
the cycle is weighing short-term performance market is inexpensive relative to the last 10 years,
considerations against long-term investment and the US and Europe ex-UK are particularly
objectives. The temptation to make decisions based expensive. The UK is the only market close to the
on short-term market dynamics can lead to taking median of the last decade, as Brexit risk continues
positions that can be very damaging. For example, to weigh on prices (Exhibit 7).
buying a 100-year, low-coupon bond might be a
7Within markets, we remain positively disposed toward assume that multiples will expand further. While
companies with high, sustainable returns on capital fixed income offers a diversification benefit, it
that aren’t currently reflected in their valuations. In does not offer much of an income advantage over
our analysis, these compounders tend to outperform cash. It might be time to reallocate money away
throughout the market cycle and defend particularly from debt toward cash, even if it means a bit of
well in down markets. The challenge more recently a drag against quarterly benchmarks. It also could
has been finding compounders at an attractive be a good idea to allocate away from debt toward
valuation. That said, in a market that is likely to be compounding equities, as the risk-reward profile
driven by earnings growth rather than valuation is at least more balanced for companies that can
expansion, we also believe that security selection is sustain high returns.
likely to be a much more important driver of total
return than in recent years. Conclusion
Overall, we believe equity market returns in 2020 In summary, investors should expect slower growth
are likely to be confined to the mid-single digits and very accommodative monetary policy in 2020. We
with fixed income total return between 0%−5%. believe the global economic backdrop will continue
Going forward, it is critical that investors right- to be challenging as we enter 2020, but recession is
size their expectations for returns, as it isn’t safe to not our base case. Rather, our base case is that the
global industrial slowdown will find a bottom without
spilling over to the service sector. Factors to watch in
Exhibit 7: Equities Range from in Line to Expensive the year ahead include trade tensions and their impact
Relative to History on the economy, the resiliency (or lack thereof) of
Forward P/E (Next 12 Months) through Past 10 Years
US labor markets, the evolving global technology
ecosystem, and US politics.
(x)
20 Taking stock of the situation, we see modest upside
10th–25th & 75th–90th Percentile 13 November 2019
for equities driven by earnings growth. We would
25th–75th Percentile 10-Year Median
caution that at this point in the cycle, investors should
16
take opportunities to upgrade the quality of their
holdings with a focus on valuation and fundamentals
12
such as high returns on capital, strong balance sheets,
and robust cash flow. In fixed income, while we see
no reason to worry about a sharp backup in rates or
8 a spike in defaults in the near term, we are wary of
S&P MSCI MSCI MSCI MSCI MSCI
500 Europe UK Japan EM China reaching for yield by taking on duration and credit
ex-UK
risk. Finally, we believe this is a market environment
As of 13 November 2019
in which security selection is likely to be a much more
Median and percentiles calculated based on month-end values. meaningful portion of total returns, as equity market
The figures above represent expected returns. Expected returns do not
represent a promise or guarantee of future results and are subject to change.
appreciation is likely to be capped in the mid-single
Source: FactSet digits and bond returns may well be even lower.
For more insights from Lazard Asset Management visit our website. www.lazardassetmanagement.com
8Notes
1 IMF World Economic Outlook. As of 15 October 2019.
2 Ibid.
Important Information
Originally published on 26 November 2019. Revised and republished on 10 December 2019.
Information and opinions presented have been obtained or derived from sources believed by Lazard to be reliable. Lazard makes no representation as to their accuracy or
completeness. This presentation is for informational purposes only. It is not intended to, and does not constitute, an offer to enter into any contract or investment agreement
in respect of any product offered by Lazard Asset Management and shall not be considered as an offer or solicitation with respect to any product, security or service in any
jurisdiction or in any circumstances in which such offer or solicitation is unlawful or unauthorized or otherwise restricted or prohibited. All opinions expressed herein are as of the
date of this presentation and are subject to change.
An investment in bonds carries risk. If interest rates rise, bond prices usually decline. The longer a bond’s maturity, the greater the impact a change in interest rates can have on
its price. If you do not hold a bond until maturity, you may experience a gain or loss when you sell. Bonds also carry the risk of default, which is the risk that the issuer is unable to
make further income and principal payments.
Equity securities will fluctuate in price; the value of your investment will thus fluctuate, and this may result in a loss. Securities in certain non-domestic countries may be less
liquid, more volatile, and less subject to governmental supervision than in one’s home market. The values of these securities may be affected by changes in currency rates,
application of a country’s specific tax laws, changes in government administration, and economic and monetary policy. Emerging market securities carry special risks, such as less
developed or less efficient trading markets, a lack of company information, and differing auditing and legal standards. The securities markets of emerging market countries can be
extremely volatile; performance can also be influenced by political, social, and economic factors affecting companies in emerging market countries.
The securities and/or information referenced should not be considered a recommendation or solicitation to purchase or sell these securities. It should not be assumed that any of
the referenced securities were or will prove to be profitable, or that the investment decisions we make in the future will be profitable or equal to the investment performance of
securities referenced herein.
Certain information included herein is derived by Lazard in part from an MSCI index or indices (the “Index Data”). However, MSCI has not reviewed this product or report, and
does not endorse or express any opinion regarding this product or report or any analysis or other information contained herein or the author or source of any such information or
analysis. MSCI makes no express or implied warranties or representations and shall have no liability whatsoever with respect to any Index Data or data derived therefrom. The
MSCI Index Data may not be further redistributed or used as a basis for other indices or any securities or financial products.
This document reflects the views of Lazard Asset Management LLC or its affiliates (“Lazard”) based upon information believed to be reliable as of the publication date. There is
no guarantee that any forecast or opinion will be realized. This document is provided by Lazard Asset Management LLC or its affiliates (“Lazard”) for informational purposes only.
Nothing herein constitutes investment advice or a recommendation relating to any security, commodity, derivative, investment management service, or investment product.
Investments in securities, derivatives, and commodities involve risk, will fluctuate in price, and may result in losses. Certain assets held in Lazard’s investment portfolios, in
particular alternative investment portfolios, can involve high degrees of risk and volatility when compared to other assets. Similarly, certain assets held in Lazard’s investment
portfolios may trade in less liquid or efficient markets, which can affect investment performance. Past performance does not guarantee future results. The views expressed
herein are subject to change, and may differ from the views of other Lazard investment professionals.
This document is intended only for persons residing in jurisdictions where its distribution or availability is consistent with local laws and Lazard’s local regulatory authorizations.
Please visit www.lazardassetmanagement.com/globaldisclosure for the specific Lazard entities that have issued this document and the scope of their authorized activities.
HB30897You can also read
