Part II: Record Economic Expansion and Reduced Recession Indicators Drive Consensus Views for 2020
As we enter the New Year and consider what to expect from the markets in 2020, I thought it pertinent to first understand the prevailing consensus views, and the associated risks, that are poised to drive market returns. The first five consensus views can be read in Part I. Part II concludes with consensus views on geopolitical shocks, overseas versus domestic market performance, growth versus value stocks, the prospects for earnings growth and multiple expansion, and lingering trade policy concerns.
6) Geopolitical shocks will have a limited impact on the market. Why would anyone feel differently given the market’s seemed “Teflon” nature over the last decade as it pertains to North Korea, Iran and the broader Middle East, Brexit, China, Hong Kong, Russia, terrorism/cyberterrorism, etc.? Similarly, impeachment and the perpetual twists and turns of the Trump Administration have been little more than an afterthought for equities. Oil price shocks, a traditional bear market precursor, have become less dramatic in recent years as the US has become more self-sufficient.
Alas, our sense is that investors have likely been lulled into a false sense of security and that political and military strife could still weigh heavily on global growth if conditions deteriorate. For example, the 1990 Gulf War, the 9/11 terrorist attacks and the 2003 Iraq invasion all triggered meaningful selloffs. Business confidence is already fragile throughout the world as indicated by assorted cap ex and purchasing manager surveys. However, the greater risk, particularly in the US, is that the remarkably resilient consumer confidence levels could come under pressure if weak business confidence translates into a deteriorating labor market. Again, markets seem poised to continue to climb the proverbial wall of worry in 2020, but given prevailing valuations and apparent complacency (the VIX “spiked” from 12 to 15 the market session after the killing of Iranian General Soleimani—still an historically moderate level), any threat to “Goldilocks” US growth of ~2% and global growth of ~3% should be taken seriously.
7) Overseas markets will outperform the US after a decade of dramatic underperformance. Steve Galbraith was Byron’s successor at Morgan Stanley and another mentor of mine with tremendous contrarian instincts predicated largely on the time-tested reality that markets tend to mean-revert. Of course, there are no guarantees as to when that reversion will occur. The MSCI All Country World ex US Index returned 70% last decade—nice enough, but still dwarfed by the 256% gain in the corresponding MSCI US Index. Going back to 1988, as far back as data is available, the ACWI ex US has gained ~860%. The MSCI US Index return has exceeded 2,700%.
I won’t rehash the reasons for the dramatic disparity, although the key elements likely include US dominance of the digital economy; a strong US dollar; and generally higher US levels of ROE, labor flexibility, and the rule of law. Positive demographics have also helped the US, particularly relative to Europe and Japan, although reduced immigration and the upcoming Baby Boomer retirement wave are likely to reduce that tailwind. China, in particular, is also becoming a far more formidable rival to America’s technology leadership. Suffice it to say, any reversion to the mean between the two indices could be enormously powerful. As we have noted previously, it is extremely difficult to compare valuations across geographies largely due to different sector compositions (e.g., the greater US technology weighting). However, the MSCI US Index entered 2020 at 18.4x one-year forward earnings—a 13% premium to its 25-year average multiple. The MSCI Ex US Index was at 15.0x—in-line with its 25-year average.
8) Value stocks will recoup some lost ground relative to growth stocks. This is another area where mean reversion seems overdue. After all, the Russell Pure Growth Index was up 106% over the past three years versus a 17% gain in its Pure Value counterpart—one of the largest disparities on record and a continuation of a decade-long trend. In a period of sustained low interest rates and low to moderate economic growth, investors have been willing to pay a premium for companies that could truly grow, be it the oft-cited FANG-like stocks, momentum-oriented industries such as biotechnology, or many private “unicorns.” The market’s growth bias has been a key element behind the underperformance of active managers versus passive indices. Most Wall Street strategist surveys for 2020 indicate a preference for value over growth, including value-oriented cyclicals such as many Energy, Industrial and Material stocks. Perhaps the continued fallout from the poor post-IPO performance from companies such as Uber and Lyft—as well as the pre-IPO flame-out of WeWork—will dampen the animal spirts that have supported growth. Another possibility is that aggressive antitrust activity directed at high profile tech-oriented darlings will hasten a rotation back to value. However, my base case is that growth stocks will at least keep pace until the longstanding “Goldilocks” economic growth and interest rate backdrop changes. Looking out over the next decade though, as opposed to the next year, value should recoup much of its recent lost ground, in my view.
9) S&P 500 earnings will grow ~5-8%, while the market’s PE multiple remains flattish. The spectacular 31% gain in the S&P 500 last year was fueled almost exclusively by multiple expansion as S&P 500 earnings were likely flat for the year. The consensus expects a reacceleration in 2020 earnings based on better global growth (aided by a reduction in global trade tensions), increased productivity, and a somewhat weaker US dollar. Alas, the Wall Street consensus at the beginning of the year almost always expects earnings to accelerate nicely—only to have negative revisions ultimately usually set-in. While we do not expect rising labor costs to translate into a significant uptick in core inflation, we do expect labor and assorted input costs to continue to pressure corporate margins that remain near historical peaks. We would therefore be surprised if US EPS growth exceeded 5%, even with continued support from share buybacks.
In terms of multiples, one of Byron’s 10 Surprises for 2020 is that he sees continued multiple expansion fueled by easy monetary policy throughout most of the world. He may well be right, but to the extent super-low/negative interest rates are buttressing that multiple expansion, one should bear in mind that there is undoubtedly a tipping point where negative rates became counterproductive for economic growth. There are surely many PhD dissertations underway on that very topic right now. They will just as surely reach many different conclusions. One of them may ultimately even prove to be right. But the stark reality is that the post-crisis financial world remains very much in uncharted territory and no one truly knows whether the unprecedented policy response is increasing the probability of a long, sustained global recovery, pumping up the next great asset bubble, or simply laying the groundwork for the “Japanification” of the global economy.
10) Trump’s trade policies will amount to far more bark than bite. To the extent that the trade tensions were often viewed as the key swing factor for economic growth and markets throughout 2019, it seems wrong to leave them completely off the list of key items for 2020. (For the record, we continue to believe that the Fed’s dovish turn was the key catalyst behind the 2019 market surge, although that posture was certainly linked in part to trade fears). The implied probability of a trade resolution with China (GSSRTRAD on Bloomberg for those who want to keep track real time) reached 85% earlier this month—the highest level since June 2018. That strikes me as overly optimistic in a world where we are always just a tweet away from a new narrative.
Moreover, many of the thorniest US-China trade issues such as intellectual property and limited access to Chinese markets remain unresolved. Perhaps President Trump will de-emphasize trade issues with China, Europe, and other regions ahead of the election and focus his attention elsewhere. I don’t expect that though—protectionism and concern that the US has been out-negotiated by rival countries has been one of the few constants in Trump’s stated views dating back to the 1980s. Moreover, the 2016 election likely confirmed in his mind that the message plays extremely well to his base (as it historically has to many Democrats, a key reason that Trump’s rivals have tended to criticize some of his trade tactics as opposed to his objectives). All in all, when the choices in relation to the 45th president are between tranquility and drama, the latter seems like the safer bet—I would expect trade rhetoric to periodically resurface throughout the year, but not to escalate to the point of truly jeopardizing economic growth and the President’s perception of his re-election chances.
For Part I of the consensus series, click here.
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