Paul O’Connor, Head of the UK Multi-Asset Team, considers whether or not markets can continue to defy gravity in 2020, as we move towards a post-stimulus era.
- Risk appetite remained resilient in 2019, despite continued downgrades to growth expectations globally and broader geopolitical uncertainty.
- Tentative signs of a stabilisation in economic indicators and hopes of a truce in the
China-US trade conflict in recent months have been the key catalysts for investors’ shift towards businesses more sensitive to growth in the economy.
- An environment of persistently low interest rates supports the case for stock markets to make further gains, but the length of the current ‘up’ cycle may take its toll in 2020.
Climbing the wall of worry
The resilience of investor risk appetite throughout 2019 was impressive, given the backdrop of continued downgrades to global growth and a broadening range of adverse geopolitical developments – the ongoing Brexit saga, the US-China trade dispute, civil unrest in Hong Kong, the impeachment of President Trump and more. Still, many of these issues first emerged in 2018, which was a disappointing one for investor returns in most asset classes. Taking the two years together, we see that much of the rise in financial markets in 2019 has just been compensation for losses in the previous year (see chart 1).
The bigger picture here is of a tiring equity bull market, with many regional indices – the US aside – making little real progress over the past couple of years.
Chart 1: Many regional equity indices have made little progress since 2017
Source: Bloomberg, Janus Henderson Investors, 31 December 2017 to 15 December 2019. Notes: MSCI World ex US, MSCI EM and MSCI US indices, rebased to 100 at start date. Past performance is not a guide to future performance.
Weakening tailwinds, stronger headwinds
In broad terms, there are certainly some fundamental reasons why the equity bull market should be expected to show signs of fatigue. For one thing, the great monetary easing that defined the post-crisis financial market environment has more or less come to an end. While we foresee further quantitative easing and more interest rate cuts from central banks around the world, we expect the incremental impact from here to be modest. On top of this, global growth continues to slow. Just as some of the key tailwinds that propelled the bull market are tiring, geopolitical headwinds are intensifying.
Lower but longer
While this might all seem rather gloomy, we would argue that it is unrealistic to expect sustained strong growth so late into the global economic expansion, with monetary policy looking fatigued and global unemployment at historical lows (see chart 2). Indeed, the mood among businesses and consumers is unusually sober for this stage of the expansion.
Rather than the usual late-cycle boom in animal spirits, we are now seeing subdued levels of economic sentiment that seem consistent with moderate rates of economic growth but, more positively, offer up hope of an unusually elongated economic expansion.
Chart 2: Unemployment rates are already at historical lows
Source: Bloomberg, OECD, Janus Henderson Investors, December 1983 to December 2019.
While we see a case for an unusually extended bull market in risk assets, age should nevertheless still be expected to take its toll. We regard the broad market environment of the past two years as a reasonable guide to what might be expected in 2020: modest investment returns and occasional flare-ups n market volatility. Instead of big, sustained swings in macro momentum, policy and investor sentiment, it is probably right to prepare for mini-cycles that last just a few quarters.
Investors are toying with the sort of thematic rotation that we would expect to see in this kind of market environment; shifting away from growth-sceptical strategies and towards reflationary, growth-positive themes. Tentative signs of macroeconomic stabilisation and emerging optimism for a ceasefire in the China-US trade conflict have been key catalysts for this market rotation.
Sun now, but clouds on the horizon
The balance of evidence seems to support the view that economic data are evolving in the way required to extend the pro-growth rotation in financial markets. However, our near-term optimism is counterbalanced by the recognition of certain vulnerabilities in the global economy that loom over the longer-term outlook:
- Low inflation remains an enduring symptom of central bank policy ineffectiveness and a threat to corporate profit margins as labour markets tighten.
- While we remain hopeful that the uncertainty surrounding China-US trade relations will ease somewhat in 2020, this will not fully clear the fog of geopolitical uncertainty overshadowing the outlook.
- The Chinese economy continues to slow, reflecting both global and domestic developments. However, while we expect further Chinese policy stimulus in the months ahead, policy makers are still prioritising financial stability over large-scale stimulus, so the growth uplift in 2020 might still be fairly modest.
Bullish, for now
The unfamiliar combination of an elongated cyclical recovery fighting against some powerful structural headwinds sets a complicated economic backdrop for financial markets in 2020. We will remain vigilant to the risk that the anticipated modest cyclical recovery is overwhelmed by some of these adverse influences, but we see scope for upside surprise scenarios as well if the recovery does gain traction.
The risks to our central scenario seem both sizeable and symmetric as we enter the new year.
Bull market: A financial market in which the prices of securities are rising, especially over a long time. The opposite of a bear market.
Quantitative easing (QE): An unconventional monetary policy used by central banks to stimulate the
economy by boosting the amount of overall money in the banking system.
Volatility: The rate and extent at which the price of a portfolio, security or index, moves up and
down. If the price swings up and down with large movements, it has high volatility. If the price
moves more slowly and to a lesser extent, it has lower volatility. It is used as a measure of the
riskiness of an investment.