Going into the new year, the global economy remains wracked by trade war-related headwinds that have hampered growth and hindered business confidence. But that doesn’t necessarily mean stock market investors will bear the brunt of this pain in 2020.
To the contrary, equity markets globally are expected to outperform bond markets next year, Bank of America Merrill Lynch economists said Tuesday—citing an expected rebound in corporate earnings that will fuel investor returns, as well as upside to be found in value stocks and in underperforming markets like Europe.
After a year that saw “incredible” capital outflows out of equities and into bonds, Jared Woodard, the head of BoAML’s research investment committee, said the bank is more bullish on “risky assets” like equities and commodities than it is “defensive allocations” like bonds.
Woodard pointed to an S&P 500 that is expected to hit 3,300 points next year, as well as European equities that could rally 8% and a Brexit-hit U.K. market that could finally rebound as much as 5%. The bank noted that U.S. stock returns are expected to lag behind their European and emerging market counterparts in 2020, while high-grade U.S. corporate debt remains “particularly attractive” given $12 trillion worth of negative-yielding debt in the global markets.
Much of the upside in U.S. corporate profits this year was “driven by companies buying up their shares” in the form of buybacks, Woodard added—a dynamic that made it “easy for [companies’] earnings per share to improve.” With the matter of corporate buybacks becoming “more politically contentious” and the specter of regulation looming over the issue, companies could accelerate buybacks next year to “get in while they can,” he said.
In line with that, Savita Subramanian, BoAML’s head of U.S. equity and quantitative strategy, called for a “meaningful acceleration of [corporate] profits in 2020.” Subramanian encouraged investors to look beyond the U.S. market—which she described as “consensus overweight”—in favor of greater upside in Europe, the U.K., and “other parts of the world.”
Here are some other notable economic and market-related issues that BoAML analysts touched on in their outlook for 2020:
‘Skinny’ trade deal only a bandaid on long-term U.S.-China dispute
Despite conflicting signals that send the market either climbing or reeling on a seemingly weekly basis, it appears “the stars are aligned” for what Ethan Harris, BoAML’s head of global economics, termed a “skinny deal” between the U.S. and China in their ongoing trade dispute. That’s because the Trump administration has “strong incentive” to strike an accord that will help fuel confidence in the economy going into next fall’s presidential election, Harris said.
What’s more, while most of the tariffs on Chinese goods imposed by the U.S. to date have predominantly impacted sectors like manufacturing—forcing companies to recalibrate their supply chains—the “last round” of pending tariffs that lay in waiting would disproportionately affect consumer goods, which would more acutely hit Americans’ pockets.
Still, the trade war’s greatest impact has been on business confidence. Even companies that have shifted their supply chains from China to Vietnam, Harris noted, have had to stay on their toes amid the president’s threat of possible action against Vietnam earlier this year. “The main effect of the trade war has been freezing up business investment for any company” with an international presence, he said.
A “skinny deal,” meanwhile, would be a mere ceasefire amid what’s poised to be a long-term dispute between the world’s two largest economies. “This trade war isn’t about soybeans; it’s about technology and national security,” Subramanian noted.
Harris added that there could well be another “escalation” in the dispute once the election year has passed. “A lot of companies are going to be worried about where we are two years from now.”
‘Bombed out’ value stocks primed for a comeback
With the trade war likely not going anywhere and immense political uncertainty on the horizon, domestic equity sectors like tech and health care could be in for some pain in 2020. Those two sectors are “likely to be pressured the most” by macro headwinds, according to Subramanian, given tech companies’ exceptional exposure to global trade and the spotlight that’s been placed on health care in advance of the upcoming presidential election.
In turn, the market could be “shifting from an environment where growth stocks have led to one where value stocks will lead,” she said—with the likes of financial stocks, which have been trading at exceptionally cheap valuations, among the beneficiaries.
“We’re very rarely at a point where value stocks are as cheap and bombed out as they are today,” Subramanian said, adding that it’s a “very good time” to buy relatively cheap stocks “just on valuation.” (Beyond the U.S., Woodard described European financial stocks as “among the deepest value opportunities in the world.”)
Economic ‘bottoming’ could hurt consumers
The economic growth picture for next year is relatively bearish compared to recent times, with the U.S. economy to expand 1.7% in 2020, according to BoAML head of U.S. economics Michelle Meyer. There’s similarly tepid forecast for other economies; China, for instance, is projected to grow 5.6% next year, which besides missing the country’s targeted 6% growth rate could well be inflated by “official government stats,” Harris said.
The trade war may well have “sliced off seventh-tenths of a percent” off of the U.S.’s growth rate, Harris added. Yet while domestic manufacturing is among the sectors to have borne the brunt of the headwinds, the overall economy has experienced “minimum spillback,” Meyer said. Consumer spending remains robust, while a continually strong labor market would back the argument that a recession is not on the cards
That could change in 2020, however. Meyer predicted that consumer spending “should slow on a trend basis” next year, while non-farm payroll growth could also decelerate—albeit to a rate of around 120,000 jobs per month that would keep unemployment under 4%.
Such numbers alone wouldn’t be enough to spur the Federal Reserve into action as far as further interest rate cuts, Meyer added. (“The Fed would very much like to do nothing at this point,” she noted.) But should the trade war escalate and the markets begin to “behave badly,” she said the Fed would move to prevent any further deterioration in economic conditions.
Despite its lukewarm growth projections, BoAML delivered an altogether positive outlook of the economy next year. The bank forecasts a “bottoming” of conditions in the first half of 2020 that would give way to a “mini-boost” in growth in the second half of the year—provided the U.S. and China reach some sort of trade resolution.
Bad CEOs have ‘destroyed’ $500 billion in value
Subramanian noted the increased prevalence of ESG-related criteria in the market, and tied it in with what she described as “record year” in terms of CEO turnover. Whether it was “improper conduct” or “not having key stakeholders in mind when making key decisions,” she said governance-related controversies at public companies had proven “very costly” to shareholders.
According to Subramanian, such controversies had “destroyed almost half a trillion dollars of U.S. market capitalization” in 2019, with a “huge chunk” of that value “wiped out by infractions on the ESG front.”
Those losses have had a “very material impact on stock performance,” she added, with the importance of ESG criteria among public investors only expected to grow in the coming years.
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