As we made our way through 2019, signs of softening economic conditions became increasingly apparent, even while consumer confidence remained high and job growth came in better than expected. Now, as we look ahead to a new year, the path is somewhat unclear. Will the economy continue in slow-growth mode? Or will we see the recession many media and industry pundits have warned about?
The course 2020 takes will depend on how the overriding trends evolve. The risk of recession is real, but we’ve been in similar situations during this decade-long recovery, only to see the economy continue to grow. That continued growth remains the base case for several reasons.
First, there are signs that the economic news may be improving. Housing, for example, has been making gains lately, while personal income and spending levels have also improved. Second, the political risks are starting to subside. The impeachment inquiry is likely to be resolved by early 2020, as will Brexit and, very possibly, the U.S.-China trade war. With the resolution of these issues, the perceived risks would be reduced materially, which would help both the economy and markets. On the policy front, the Federal Reserve (Fed) has been reducing rates, and there is a real possibility that the monetary policy environment will transform from a headwind in 2019 into a tailwind in 2020.
That’s why there’s a strong case for continued slow growth through 2020. Corporate revenue and earnings should continue to increase, probably by more than most analysts expect. If growth trends meet expectations and confidence levels remain steady or improve, financial markets are likely to be stable and may even appreciate.
The economy today looks a bit slower than it did a year ago. Consumers are still spending, but businesses are investing less. Government spending growth should continue, but it is unlikely to accelerate. Trade is not likely to be an additive force, and it might well end up as a drag. These factors should leave growth slightly slower overall for 2020, at around 1.25 percent to 1.75 percent.
The Fed’s Monetary Policy
The real monetary policy story of 2020 is likely to be that there is no story. With slower economic growth, and with inflation around 1.5 percent to 2 percent, the Fed may institute more rate cuts. This would leave the federal funds rate in a range from 1.25 percent to 1.5 percent by year-end 2020. In turn, the 10-year U.S. Treasury yield would be around 1.75 percent to 2.25 percent. Of course, in the case of a recession, the Fed would likely take a more active stance.
A growing economy and a supportive monetary policy should support global stock markets, leaving them to trade on fundamentals. Revenue growth remains healthy, consistent with continued strength in consumer spending. Strong revenue growth should also support growth in earnings.
The remaining question concerns valuations. Through most of 2019, high levels of consumer confidence drove market valuations higher. If current prices hold, we should finish the year at the upper end of the range typical of the past five years or so. But as confidence levels moderate and growth slows throughout 2020, we can expect valuations to drop down closer to the lower end of that range.
As a result, the S&P 500 is likely to end 2020 between 2,900 and 3,200. There is upside potential if valuations remain near current levels. But downside risk exists, as valuations are quite high historically.
The International Story
If the U.S. is likely to continue its slow growth path, what about international economies and markets? From a market perspective, valuations are generally cheaper abroad, which could lead to international markets outperforming those in the U.S. We’re already seeing signs of this outperformance. That said, there are risks on the international front. The trade war, if not resolved, will continue to weigh on global growth and markets, as would a U.S. recession. International markets are likely to deliver both higher reward and risk than U.S. markets in 2020, although results will be primarily dependent on what happens here.
What About a Recession?
The predictions above assume continued slow growth and steady markets. But if we do get a recession, what would it look like?
To start, it’s very unlikely to be as bad as the Great Recession of 2008. Current high employment levels and wages should keep consumer spending (at two-thirds of the economy) healthy, even during a downturn. Business spending is already flat. Government spending growth, meanwhile, should act as a cushion. In other words, a recession will probably be more of a deep slowdown than a collapse. This scenario is what we saw in the recessions of 1990 and 2000, and current conditions resemble those years more than 2008. The 2000 recession was not fun—but it was not like the crisis of 2008.
From a market perspective, we can draw the same conclusion. With interest rates low, stock market valuations have moved higher over the past several years. If S&P 500 valuations dropped to their lowest recent level, the index would decline about 18 percent—much less than the drops we saw in 2000 or 2008. Plus, a decline like this would be consistent with other S&P declines over the past couple of years. So, even if earnings decrease or valuations drop further, we could conclude that the market impact of a recession would likely not be nearly as bad as in 2008.
More of the Same
The past year was eventful, particularly in terms of political risks. Still, the economy and financial markets continued to grow, as the underlying fundamentals remained sound. The fundamentals are weakening, but the most likely outcome is continued slow growth. Even if growth becomes muted (both here and abroad) or any other issues (known or unknown) emerge, the underlying strength of consumer spending should limit the damage. And if we do get a recession? The impact is likely to be much milder than many of us fear.
Overall, 2020 looks likely to begin with more of what we’ve seen so far in this expansion—just slower. Despite the rising risks, which have the power to change things quickly, this is not a bad place to be.
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