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2019 was a great year for markets, and both equities and bonds delivered strong returns for the year. US stocks returned 28.9%, European stocks returned 20.0%, emerging markets delivered 15.4%, US bonds returned 8.7%.1 Ongoing geopolitical issues, like Brexit and trade, and short-term market events, like the inverted yield curve, provided some moments of pause but the market seemed to quickly shrug off each of these events.
Looking forward as 2020 begins, some of the recent macro themes remain the same, while others are just beginning to take shape. With crystal ball in hand, here are 5 macro themes for 2020.
Trade (with China et al)
With a limited phase 1 US-China trade deal due to be signed on Jan. 15, a fragile détente seems to have been reached. However, trade will most likely continue to be a market moving theme in 2020. The potential resolution of US-China trade tensions could be negative for the eurozone economy as the US turns its trade-attention on the European Union. It is difficult to form conjecture based on week-to-week rhetoric from Trump and members of the administration, but the overall theme of US driven trade skirmishes will continue into 2020. As we experienced in 2019, these tensions, wherever focused, will also add to the volatility of the markets with any resolution being generally buoyant for equities both here and globally.
With no intended reference to political mascots, the thematic elephant in the room is the November US elections. Markets will pay close attention as the field of Democratic candidates for the presidency narrows during the primaries. Political uncertainty always accompanies an election cycle but market could react more dramatically if progressive high-tax, high-regulation platforms gain more support during the primaries. Any potential for a significant shift in tax policy or federal government regulation will create volatility, especially in certain sectors like technology, energy, financials and healthcare. But it’s important to remember that the turn of election is generally not a reason to make wholesale changes to a portfolio’s allocation. Of the last 11 presidents, only 2 have had terms where the S&P 500 had negative returns. Elections are not irrelevant and do have short-term market effects but it is important to remember economic fundamentals drive the market over any longer-term market cycle.
Middle East conflict
After the US killing of a senior Iranian official in Iraq last week and Iran’s retaliation with missile strikes on Iraqi bases housing US service people, tensions have eased a bit. Market reaction has been muted so far but growing conflict in the region is more than just these recent events. With Iran announcing its withdrawal from the nuclear weapons accord, experts suggesting possible Iranian retaliation via cyberattack, and Iraq’s vote to expel the US from the country, it seems we are nearer the beginning than the end of this middle east conflict cycle. Barring any significant deterioration in business sentiment, the conflict will likely only add to short-term volatility and not long-term economic fundamentals which drive the market's long-term performance.
The Federal Reserve vs. Inflation
As always, the Fed’s interest rate policy plays a major role in market performance. The recently released minutes from the FOMC’s (Federal Open Market Committee) December meeting, indicate the Fed will keep rates where they are - so likely no rate cuts in 2020 and, given persistently low inflation, the bar remains high for any rate hike. The caveat is the potential for a surprise in inflation stemming from labor cost increasing as employers have to bid up rates in this historically tight labor market. If the Fed were to somehow become even slightly more hawkish (more wary of inflation), that could be problematic for US stocks.
Low Global Interest Rates and slow Fiscal Policy (a theme for the new decade)
Near-term recession risks have diminished in recent months, helped, in part, by additional global monetary easing. The Fed and other major central banks have helped to extend the global expansion by adding stimulus in the form of historically and persistently low interest rates. I argue that this is the correct response to stimulate global and domestic growth, but such low interest rates may come at a price. Whenever the next economic downturn or major market drawdown hits, the Fed and other central banks will have less room to move interest rates lower, limiting their ability to fight future recessionary forces. In theory, fiscal policy in the form of tax changes or government spending, would be able to step in to stave off or minimize recession. In practice, governments are not able to diagnose recession risks early enough and act swiftly enough to implement fiscal easing in time to prevent a recession. Thus, central banks will still have to be the first responders in the next crisis and, again, will be more constrained than they have been in the past. This is not an immediate issue for the economy but is an economic theme that will be constant until interest rates can normalize, something that may not happen the 2020’s.
1 Source: Morningstar. US stocks represented by the S&P 500, European stocks by the MSCI Europe Index, emerging market stocks by the MSCI Emerging Markets Index, and US Bonds by Barclays Aggregate Bond Index.