What great changes have taken place in one year.
A year ago, worries about rising interest rates, slowing economic growth, escalating trade disputes and the end of the bull market surged. However, as the Federal Reserve cut interest rates, investors (as our market strategist predicted in December 2018) turned their main attention to positive factors, while the stock market climbed to a record high in the 11th year of the bull market.
However, the market faces many new and old risks and the valuation level also poses challenges. According to 10 strategists surveyed recently by Barron, this indicates a less brilliant future in 2020. According to their average forecast, the S&P 500 index will rise 4% in 2020. With a dividend yield of about 2%, the stock’s total return in 2020 may reach about 6%.
For the coming year, people’s doubts are not only about basic asset allocation. The impact of trade dispute negotiations and elections may lead to a series of results. This means that there may be turbulence in the market. With a preliminary trade agreement reached on December 13, 2019, the stock market closed up sharply this week.
“A key issue in 2020 is that it is difficult to predict the potential factors driving the market trend, because this is a geopolitical issue, a political issue, not a fundamental factor.” Saira Malik, head of Nuveen equities at the investment department of the American Teachers’ Insurance and Annuity Association (TIAA), said.
In 2019, the S&P 500 index rose 28.88% to close at 3230.78 at the end of the year. As prices soared, bond yields fell sharply: 10-year U.S. Treasury yields fell to 1.90% from 2.68% at the beginning of 2019. As the U.S. economy is relatively strong and bond yields (perhaps lower) remain at least positive, U.S. assets generally outperform overseas assets.
US Economy: Slowing but Still Growing
The strategists we surveyed believe that the average forecast of real GDP growth in the United States in 2020 will slow to 1.9%, lower than the forecast growth of 2.3% in 2019. In contrast, the growth rates in 2018 and 2017 were 2.9% and 2.4% respectively. However, that level of growth is far from recession. According to people’s previous general expectations, the economic recession has arrived at this moment.
Rick Rieder, chief investment officer of BlackRock’s global fixed income business, believes that consumers will remain the driving force of the us economy in 2020. The unemployment rate is 3.5%, and wage growth accelerated in the second half of 2019, surpassing the inflation level. This means that consumers’ spending power has increased-which is good news for the U.S. economy, as consumer spending accounts for about 70% of GDP. Meanwhile, households remain optimistic and consumer confidence indicators are still close to cyclical highs.
“We believe that consumption is still quite stable, housing construction is in good shape, and consumer employment and wages remain strong.” Reed said, “Therefore, we believe that this will keep the economy in good condition.” He expects US GDP to grow by 1.8% in 2020.
There is a broad consensus among strategists on this point, and some strategists also see signs that the manufacturing industry is about to recover. Tobias Levkovich, chief U.S. equity strategist at Citigroup, regards a quarterly Fed survey of senior loan officers as a leading indicator of industrial activity. This indicator, which measures commercial and industrial loan standards, shows that the credit environment in the spring and summer of 2019 is relatively relaxed, indicating that industrial activity will rebound in the first and second quarters of 2020.
Levkovich predicts that the real GDP growth rate in the United States in 2020 will be 2%, while the first half will be higher than the second half. The same quarterly survey of loan standards shows that economic growth will slow in the third quarter. Rob Shipes, head of investment at T.Rowe Price Group, also believes that the rebound in manufacturing will drive economic growth in 2020.
Monetary Policy: Continue Loosening
The Fed’s big shift from raising interest rates in 2018 to cutting interest rates three times in 2019 played an important role in the stock market’s climb to a record high in 2019. Lower interest rates support higher stock valuations because they make the discounted present value of future earnings higher. Investors seeking dividend income also have greater demand for dividend-paying stocks, and the reduction of borrowing costs makes the cost of stock repurchase lower.
The P/E ratio of the S&P 500 index (that is, the price investors are willing to pay for every dollar of earnings) has risen from 15.4 times at the end of 2018 to 19.3 times at the end of December 12, 2019. This has pushed up the stock market, although economic and profit growth has been slow.
“In 2019, we saw that the profit was basically the same-the profit decreased slightly after eliminating repurchase, and all the returns came from the increase of P/E ratio.” Savita Subramanian, head of equity and quantitative strategy at Bank of America Securities, said, “our logic is that low interest rates will lead to higher price-earnings ratios, but we may not have seen an increase in valuations when growth slows to current levels.”
Central banks around the world have adopted a more relaxed policy stance. The European Central Bank and the Bank of Japan both use negative interest rates as benchmark interest rates. This makes the already low U.S. yield a “high yield” by comparison. At the same time, the demand of foreign investors may inhibit the room for the US Treasury bond yield to rise in 2020. None of the strategists we interviewed believed that the 10-year bond yield would rise to more than 2.20% by 2020.
Federal Reserve Chairman Jerome Powell hinted that the Federal Reserve would remain on hold unless economic data really changed expectations. In 2020, investors may not expect more interest rate cuts to further increase the stock price-earnings ratio, but central banks still support the market in other ways.
“The European Central Bank, the Bank of Japan and the Federal Reserve are currently quite active in expanding their balance sheets at a rate of about US$ 100 billion per month.” Mike Wilson, chief US equity strategist at Morgan Stanley, said. He said that this would curb volatility and “lead to asset price increases in almost all sectors”.
Credit Market: Focus on Quality
Like stocks, corporate credit bonds will generally go up in 2019. The simultaneous decline in interest rates around the world has prompted investors to seek fixed income. They have bought bonds, pushing down the yield. This makes it more difficult to find attractive opportunities in the credit market in 2020.
“As the interest margin has narrowed so much and the yield has fallen so much, I think the credit market is at best fair.” Reed of BlackRock said, “If you want to hold some credit bonds in your portfolio, we recommend those high-yield bonds with higher credit quality and some investment-grade bonds with medium credit quality. But in 2020, our willingness to hold credit bonds is much lower than in 2018 because valuations are not so attractive. ”
In addition to narrowing interest margins, the central bank’s asset purchase program to increase liquidity also makes it possible for enterprises to obtain financing that might otherwise be questioned by investors. Edward Yardeni, president and economist of Yardeni Research, pointed out that half of the investment grade bonds are currently rated BBB or equivalent. He warned investors to pay attention to high-quality companies with stable balance sheets and cash flows.
“One of the consequences of the Fed’s easing monetary policy again is that they are funding zombie companies. If the cost of credit were not so low and so easy to obtain, these “zombie companies” might have gone bankrupt by now. ” Yardeni said, “With global interest rates so low, investors are chasing yields, which means they have been buying junk bonds.”
But as long as the United States can avoid recession and the financing environment remains relaxed, zombie companies are likely to continue. Richard Lacaille, global chief investment officer of State Street Global Advisors, believes that investment grade credit bonds and some high-yield bonds will rise moderately in 2020.
“The credit expansion machine continues to operate.” Lacaille said, “At present, this is very effective. Investors have a great demand for interest rate differentials, and I don’t think there will be a sharp rise in default in 2020. ” Considering that long-term bonds are squeezed by strong demand from pension funds and other long-term investors, he prefers short-term credit bonds.
Impact: Elections and Trade
The two uncertain factors in 2020 are the Sino-US trade dispute and who will win the US presidential election. These two factors may have a significant impact on the market in 2020, and both are difficult to predict.
Two of the world’s largest economies have been involved in trade disputes for more than a year. Multiple rounds of tariffs and countervailing duties have affected almost all merchandise trade between the two countries. For an economy of the size of the United States, the impact of these tariffs is not significant, but the impact on business confidence and investment is much greater. In the autumn of 2019, optimism about a preliminary agreement pushed up the US stock market.
In the third quarter, the Conference Board’s index of CEO confidence fell to its lowest level since the financial crisis in early 2009, and capital expenditure remained relatively low.
Welcome a Year of Moderate Rise
J.P. Morgan’s forecast of earnings per share in 2020 largely depends on developments in the trade field. Dubravko Lakos-Bujas, its chief U.S. equity strategist, gave a benchmark forecast that China and the United States would reach a partial solution to help push earnings per share up 10% to $180 in 2020. The total elimination of tariffs will raise the figure to 184 US dollars, while escalating the dispute and increasing additional tariffs will keep earnings per share at 171 US dollars, up only 4%. This $13 gap illustrates the possibility of very different results.
Morgan Stanley’s forecast of a rebound in the economy at the beginning of 2020 also depends on an improved trading environment. “Our economists are very clear about this.” Wilson said, “If we can’t make some progress, then their forecast of a bottom in the first quarter may be too optimistic.”
Another uncertain factor is the US presidential election. Strategists are most worried about the huge difference between the policy proposals of the political left and right. Investors and businesses may suspend their actions in the months leading up to the election until the situation becomes clearer.
Some strategists interviewed believed that Trump’s re-election would be the most optimistic result. “My assumption is that Trump will win and the market will think his victory is favorable because he supports deregulation and is very pro-business in general.” Yardeni said.
Lori Calvasina, head of U.S. equity strategy at RBC Capital Markets, pointed out that two-thirds of the agency’s equity analysts believe that the victory of progressive Democratic candidates such as Elizabeth Warren or Bernie Sanders will be a negative factor for the industries they are tracking.
Shapps of Prussian believes that the scope of this negative impact is not limited to companies that have been identified in certain fields, such as health care and energy. “Some policies being promoted by some more progressive candidates may pose real challenges to industries such as energy and financial services, which will have a multiplier effect on the economy.” He said.
Stock: keep looking, but don’t be greedy
In 2020, when the valuation level is close to the record high, the profit recovery growth will push up the S&P 500 index.
The general view of the strategists interviewed is that the stock valuation should remain at the current level, either slightly rising or flat until the end of the year, while the profit will increase. Their average forecast is that earnings per share will be about $174 in 2020, 6% higher than the consensus forecast of $164 in 2019.
“Profits Will Push Bull Market Higher.” Malik of Nuveen said, “For 2019 or 2020, the profit increase will not be too big … In fact, we expect the price-earnings ratio to shrink slightly.” He believes that the S&P 500 index will reach 3,100 points by the end of 2020, roughly equivalent to the level of the index at the end of 2019.
Yardeni, the most optimistic of the strategists interviewed, believes that the Fed’s easing, progress in trade negotiations, and the pursuit of earnings will push investors to switch to dividend-paying stocks, which will push the S&P 500 index to 3,500 points by the end of 2020.
However, the way forward for the stock market may be bumpy. Headlines on trade, economy or elections are likely to push volatile markets up or down for a long time.
“The possibility of adjustment between now and the end of 2020 is very high.” Shipes said, “Our position today may not be your best buying opportunity in the end.” He believes that the S&P 500 index will rise to 3,250 points in 2020.
Wilson’s end-of-year target for the S&P 500 index is 3,000 points, lower than the current level. However, he believes that the market is likely to rise in early 2020. “Liquidity is quite abundant and will remain so at least in the first quarter of 2020.” He said, “The risk of economic recession in the short term is very small and people feel more optimistic, so we may see that the valuation will overshoot upwards in the next three to four months.”
Plate: Buy Underestimated
According to the strategists interviewed, finance, health care and industry are all sectors worth choosing in 2020. In each of their forecasts, valuation is more attractive than the rest of the market segment is one of the important factors. The expected price-earnings ratios of these sectors are 13.3 times, 15.8 times and 16.5 times respectively, while the S&P 500 index is 17.6 times.
The most promising sector for Sabramania of BofA Securities in 2020 is finance. She pointed out that the sector is not popular now, sellers are paying less attention and fund holdings are below average. But judging from dividends and share buybacks, the shareholder return rate of this sector is the highest among all sectors. Considering that the health care and energy industries are more targeted by some candidates and that Wall Street has already borne the regulatory burden, Sabramania is not worried about the election risks facing the financial sector.
Health care is likely to be the sector most affected by election-related risks, as candidates’ proposed Medicare for All and drug pricing bills pose a survival threat to most areas of the industry. However, many strategists interviewed believe that this kind of risk has been fully understood and digested by the market. They believe that the single payer system is unlikely to be passed by Congress and become a law.
At the same time, in the long run, demographic trends favor companies that have health care businesses. Compared with other areas of the market, the valuations of these enterprises are also attractive. “A lot of worries have been digested, and these worries should abate, and the health sector should benefit from them.” Lacos-Buhaas of JPMorgan Chase said.
Calva Sinar of the Royal Bank of Canada Capital Markets said that when manufacturing indicators such as the PMI improve, it is time to buy industrial stocks. “In a few years, we will all look back and hope that we have bought a lot of machinery stocks during the trade dispute.” Calva Sinar said.
Shipes also believes that the industrial economy will improve in 2020. He recommended UPS(UPS a quality stock that could rebound. For investors with high risk appetite, companies with large cyclical risk exposures such as Texas Instruments (TXN) and United Airlines (UAL) deserve attention. He also believes that investors have the opportunity to buy industrial stocks and earn some dividend income at more attractive times than the debt stocks such as real estate or public utilities.
“You can find dividends in many stocks.” “I think if I try to invest in dividend-paying stocks, I will pay less attention to companies that are resilient and less sensitive to the economy, and pay more attention to stocks that have certain periodicity,” Sharps said. These stocks include United Pacific Company (UNP), with a dividend yield of 2.2%. Alaska Airlines (ALK), with a yield of 2.1%. Both stocks can benefit from the momentum of the U.S. economic upturn in 2020.