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Promotional material published by Metzler Asset Management GmbH - 23.12.2019 - Edgar-Walk

Metzler outlook for 2020: The longest bull market in US economic history is slowly coming to an end

Stable growth of the global economy coupled with ample liquidity from the central banks should open up price potential on the global equity markets at the beginning of 2020. However, US equity valuations are very high which means there is hardly any upside left on the US equity markets in the medium term because profits will first have to catch up again with prices. The equity markets in the rest of the world will not be able to decouple themselves from this, but they still offer attractive dividend yields for investors. 

The global economy occupies a grey area

In contrast to the price fireworks on the financial markets, 2019 was a great disappointment in economic terms. As recently as June 2018, the Bloomberg consensus predicted the global economy would grow by 3.7% in 2019, but by December, the growth forecast was only 3.0%. According to several analyses, this was due mainly to the global trade conflict and the heightened uncertainty it had caused. The further development of the trade conflict is therefore a decisive factor for the economic outlook for 2020, especially since the global economy now occupies a grey area between upswing and downturn with current growth of 3.0% (according to our global economic indicator).

The global economic cycle occupies a grey area The global economic cycle occupies a grey area
Sources: Thomson Reuters Datastream, Metzler; as of November 2019

Slipping into a global downturn in the upcoming year thus looks just as likely as returning to an upswing. In general, we expect US President Donald Trump to de-escalate the trade conflict in order to reduce the risk of a US recession in the run-up to the presidential elections in November. The currently high level of uncertainty could then wane and corporate investments could pick up again. Especially Europe and the emerging markets (except for China) would be likely to benefit from moderate growth recovery, as they have suffered the most from the trade conflict so far. However, in the USA and China, growth is likely to slow down. In the USA, tailwind from a tax cut in 2018 will disappear in 2020, and in China, the structural growth slowdown is likely to continue. Overall, we expect the global economy to grow at a stable rate of 2.9% in 2020, but we also see chances for a moderate growth upturn in the course of the year. This could lay the foundation for accelerating growth in 2021.

Equity markets: only slight upside for US equities – dividends become a source of income 

Since March 2009, the US equity market has been in the longest bull market ever in US economic history and is likely to pass the 11-year mark this year. Interestingly enough, it has been mainly higher corporate profit margins and higher valuations that have contributed to the equity price gains rather than solid corporate sales growth like in the past. The higher valuations are surely based on the flood of liquidity provided by the central banks – and central banks are likely to continue doing everything they can to prevent stock prices from plunging. Assuming the economy remains rather subdued in the next few years and corporate profits rise hardly at all, central banks are likely to keep stock market valuations consistently high with an ongoing ample supply of liquidity. As a result, share price performance would stagnate in the medium term. However, if the global economy picks up and brings positive surprises, there would be dynamic profit growth. But in a scenario like that, the central banks would withdraw liquidity from the financial markets, thus causing valuations to drop. The result would be stagnating prices in the medium term. Only in a global recession would there be noticeable price losses, because profits would decline and the central banks would have little leeway to support equity valuations. 

It is thus highly likely that the US stock market will still be trading at approximately the current price level ten years from now. It is actually a comparable situation to the long upswing we experienced from 1950 to 1966, the so-called nifty-fifty bubble, which was followed by a very volatile sideways phase lasting until 1982.

US equities: still some upside but a longer phase of volatile sideways movement is likely from mid-2020 on US equities: still some upside but a longer phase of volatile sideways movement is likely from mid-2020 on
Sources: Thomson Reuters Datastream, Metzler; as of September 30, 2019

Three scenarios:

1. Stagnating profits + stabile valuation = stagnating prices
2. Rising profits + deteriorating valuation = stagnating prices
3. Declining profits + stabile valuation = declining prices 

 

This year's US presidential elections could mark the beginning of a switch to sideways markets, because Donald Trump, if re-elected, could throw caution out the window and escalate the trade conflict again. If the Democrats win, they will likely try to reduce the exceptionally high profit margins of many US companies by using tax and competition policy. Equity markets in the rest of the world will most surely follow the US stock market’s example. However, volatile sideways movement does not mean that price performance will stagnate every year; it means that years with positive and negative performance will alternate at irregular intervals. In such an environment, investors benefit from dividends and can therefore achieve relatively satisfactory performance. Risk management is also becoming more important – if losses in the portfolio can be contained while the financial markets suffer major losses and if participation in price recoveries remains possible to some extent, then additional performance can be generated.  

Outlook for the bond markets: extremely boring

Should the global economy be stable, there would be no need for action by the US Federal Reserve (Fed) and the European Central Bank (ECB). Moreover, we expect inflation to remain stable.

Yields on ten-year US and German government bonds could rise moderately by 0.3–0.4 percentage points in the course of the year because safe haven investments could become less attractive as political risks subside. Overall, yield curves would thus become moderately steeper.  

Risk scenarios: global recession and wage hikes in the USA

The global economy is currently somewhat fragile and would be in no position to counteract any new jolts, e.g. another unexpected escalation in the trade conflict or any other geopolitical event. This risk scenario is underscored further by the fact that global central banks have already exhausted most measures and high national debt in all regions could make it difficult to implement economic stimulus programs quickly. The central banks would therefore react early to any economic weakness in order to ward off the threat of recession. In this scenario, government bonds would have a good chance of realizing price gains while equities would suffer losses.

However, should optimism return unexpectedly as it did in 2017 and should companies and consumers suddenly be willing to spend more again, global economic growth could accelerate noticeably. In this case, the unemployment rate in the USA could drop to 3.0% and wage growth could accelerate to 3.5–4.0%, causing core inflation to rise from 1.6% currently to 2.2–2.4%. The high budget deficit could then accelerate rising inflation in the years to come. For 2020, the OECD expects a budget deficit of USD 1.5 trillion for the USA. In 2019, the Fed provided the commercial banks with additional liquidity so government bonds could be purchased at the prevailing interest rate; thus the Fed is already engaged in public-sector financing. In this scenario, the Fed would not be able to raise the key interest rate in 2020 because of the elections, but yields on ten-year US government bonds would rise noticeably – with negative consequences for the equity market.

Currencies: can the undervaluation of the euro finally be corrected in 2020? 

In terms of purchasing power, the euro has been significantly undervalued against the US dollar since 2015. The euro zone also has a current account surplus of around 2.8% of GDP. This means capital from real economic transactions is consistently flowing into the euro zone and should put natural upward pressure on the euro. However, a high level of political uncertainty in Europe combined with negative interest rates is likely to cause a steady outflow of capital from the euro zone to the safe haven of the US dollar, thus offsetting the upward pressure on the euro. Confidence in Europe’s political stability and economic prospects will probably have to return before the undervaluation of the euro can be corrected. However, as economic growth in the USA declines, political pressure within the USA to weaken the dollar could also increase. Chances for a somewhat stronger euro against the US dollar do therefore exist for 2020.

The euro is undervalued against the US dollar in terms of purchasing power parity The euro is undervalued against the US dollar in terms of purchasing power parity
Sources: Thomson Reuters Datastream, Metzler; as of September 30, 2019
Edgar Walk, Chefvolkswirt Metzler Asset Management
Edgar Walk

Chief Economist , Metzler Asset Management

Edgar Walk joined Metzler in 2000. As Chief Economist in the asset management division, he is responsible for formulating our global economic outlook. Due to his close cooperation with the portfolio management, he focuses on capital market themes as well as on global economic analyses. Mr. Walk holds a master’s degree in economics from the University of Tübingen in Germany and spent a semester at the University of Doshisha in Kyoto, Japan. In addition, he completed the program “Advanced Studies in International Economic Policy Research“ at the Institute of World Economy in Kiel, Germany.

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