What can we expect for the financial markets after a year that saw (at the time of writing) positive performances for asset classes across the board? In 2019, the various asset classes banded together to surprise investors on the upside, with European and US government bonds up by around 8% and Eurozone and US equities up by more than 20%[1]. Of course, 2018 was also an exceptional year ... for all the wrong reasons, with bonds and equities alike losing ground. Ultimately, in the space of two years, the S&P 500 ended up gaining 17%, versus just 5% for the Stoxx 600[2].
Performance of asset classes since 2004 (orange = negative, blue = positive)
Data at 11/12/2019, source: Bloomberg, Candriam
Right now, it’s hard to say what kind of year 2020 will be. There are several possible scenarios, but most investors are erring on the side of caution. What kind of returns are we expecting for 2020?
Forward-looking analyses are always challenging by nature. It is just as important to understand the projected scenario as it is to come up with a number.
Our central scenario calls for the stabilisation, followed by the gradual recovery, of the manufacturing cycle. It also sees trade tensions easing between the United States and China. This is a reasonable assumption considering that 2020 is a US presidential election year, but then again, has anything been reasonable thus far during Trump’s first term in office? US growth should come in for a soft landing at around 2%, European growth is expected to stabilise at around 1% and EM countries should fare better than 2019. We do not expect to see much more in terms of monetary easing, the Fed is only likely to lower the fed funds rate once in 2020. In Europe, any economic downturn is liable to be offset by fiscal easing, as another rate cut would be unlikely to prove very effective.
In this scenario, rates should stabilise and then pick up slightly once economic indicators improve. Government bonds should thus generate slightly negative performances (factoring in currency hedging for non-European bonds). Projected yields in the credit market are weak, with credit spreads having already significantly tightened in 2019.
Change in equity risk premium in the US and Europe
The risk premium on equities is still attractive. While bonds are expensive, equities are slightly less so. The projected return for 2020 can be viewed as the sum of EPS growth, dividend yield and the change in equity valuation. EPS growth could end up being somewhat positive, and much lower than the consensus (around 9% for developed country equities). Potential dividend yield is pegged at an attractive 2-3%. The year’s performances will once again depend significantly on how equity valuation multiples evolve. In 2019, the over-20% rally in the US and European equity markets rested solely on an equivalent multiple expansion. As we head into 2020, we expect a potential return of 6-7% on developed country stocks (MSCI World) and just slightly better for emerging markets.
Breakdown of projected dividend yield for developed country equity markets (MSCI World)
A positive equity valuation trend relies first and foremost on how much faith investors have in future growth. Any negative shock in terms of US election results, the resurgence of geopolitical tensions or excessively slow progress on European projects could cause investor fears to come surging back and trigger a drop in equity valuations. For the time being, low interest rates have set a floor level for any potential stock market decline, unless the likelihood of a recession were to increase sharply. Conversely, investors may end up with more nice surprises in store in the event of a positive shock: cancellation of trade tariffs imposed by the US, stronger stimulus in China, a change in perception for Europe with a substantial fiscal stimulus package and strong support for the “green deal”... 2020 is starting off with a little more hope than 2019, and that hope deserves its chance!
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[1] Data MSCI Euro and S&P 500 at 29/11/2019, source: Bloomberg
[2] Data at 29/11/2019, source: Bloomberg
