2019 was exceptional for the stock market, with a 31% return for S&P 500 and healthy double-digit advances for most major indices. This came after a particularly weak 2018, when the S&P 500 was down 4.4% and many other equity assets did worse. Interestingly, the more recent advance was accompanied by earnings weakness, while the earlier declines came with earnings strength. A Federal Reserve policy reversal really saved the day, along with some late thawing on U.S.-China trade.
Looking forward, our Asset Allocation Committee is becoming more comfortable with risk exposure in light of trade news and a modest potential recovery in economic growth, particularly in the second half of the year. In U.S. equities, they anticipate a rotation from growth to value/cyclicals, but are finding more opportunity abroad, in the U.K. (improved sentiment), Japan (stimulus) and emerging markets (leverage to improved manufacturing). In fixed income, they favor credit on the back of a stable growth and low inflation, and believe municipals can continue to benefit from heightened demand.
Looking Toward November
Politics could be particularly nettlesome in 2020. The U.S. presidential election will likely be vitriolic and sharply contested, with voters choosing among candidates with widely disparate views on taxes, foreign policy, climate, health care and other key issues. Election-related uncertainty could dampen business spending and contribute to market volatility for much of the year.
Global issues could prove disruptive as well. Although a welcome development, the current pause in U.S.-Chinese trade tensions could dissipate should the parties hit roadblocks on structural and strategic issues; the U.K. election made the path to Brexit clearer, but the terms of separation still need to be ironed out; in the Middle East, flare-ups often seem close at hand.
In light of these dynamics, our cover story focuses on political issues that we believe could affect markets in 2020. Other topics include the merits of private markets, risks and opportunities in small-caps, and investing in innovation. Finally, we offer a brief assessment of the WeWork debacle and how it demonstrates the crucial role that fundamental research and effective corporate governance can take in limiting exposure to risk.
Highlights 1Q 2020
From the Asset Allocation Committee
With the easing of certain trade tensions and apparent stabilization of manufacturing growth, the Committee is taking a more positive view on risky assets over the next 12 months. Still, we are cognizant of increased political risks (particularly in the U.S. and Mideast) and the probable lack of additional monetary stimulus this year.
U.S. Equities: High valuations and moderate earnings growth could limit the upside potential for index returns over the next year, though we see relative potential in more cyclical areas of the market. Impeachment and the November election are likely to contribute to uncertainty.
Developed Non-U.S. Equities: The U.K. election has improved sentiment by removing questions around Brexit, while planned fiscal stimulus should support the British economy. Japan’s robust consumer confidence and loose monetary policy are positives. In the euro zone, a lack of fiscal stimulus tempers our 12-month outlook.
Fixed Income and Cash: Low to negative yields on many government bonds make them unappealing, although we favor investment grade and high yield credit. TIPS (Treasury Inflation-Protected Securities) remain underpriced relative to inflation potential. We have moved cash from an overweight to neutral outlook in light of more balanced market risk.
Emerging Markets: An easing of U.S.-China trade tensions and stabilizing manufacturing data could benefit emerging markets. Corporate operating leverage tends to be higher than in developed markets, which could also be a tailwind as global earnings recover; a weaker dollar is another potential support.
Alternatives: With shifts in market risk, we have downgraded our 12-month view on lower-volatility hedge funds to neutral but maintain an overweight outlook on directional strategies. While not a bargain, private equity offers the potential for value creation from improving company operations that is often limited in public markets.
All views are over the next 12 months. See disclosures at the end of this publication, which include additional information regarding the Asset Allocation Committee and the views expressed.