2019 was an eventful year for global markets. We saw slowing growth, central banks intervening to provide stimulus, and significant geopolitical concerns. It was the year when US protectionism escalated substantially, Brexit uncertainty persisted, European political fragmentation continued, and impeachment proceedings against Donald Trump began.
While consumer spending largely remained resilient in 2019, the slowdown was most heavily concentrated in industrial and trade-exposed sectors and economies, with the US-China trade war and a meaningful decline in auto demand weighing particularly heavily on markets. Overall, global real GDP growth in 2019 is estimated at 3 per cent, down from 3.6 per cent in 2018, according to the International Monetary Fund (IMF) World Economic Outlook (as at 15 October 2019).
The key question for 2020 is whether 2019’s industrial deceleration is yet another replay of the slowdowns we saw in 2012-13 and 2015-16?
Looking ahead, our base expectation is that consumers will remain resilient, and that the US and most other major economies will avert recession—or a ‘hard landing’—in 2020.
Here we outline six key themes we will be watching for the year ahead.
1. US-China trade tensions
Throughout 2019, the world’s two largest economies were locked in a bitter trade battle. This caused both the impact of tariffs and the larger impact of uncertainty on business investment to become increasingly evident.
Despite agreements being reached early in 2020, we believe the overall trajectory for US-China trade tensions is negative, with a complete resolution of the broader dispute unlikely. The US is demanding fundamental changes to China’s economic system and could continue to roll out targeted measures that restrict US companies from selling sophisticated technology products and services to Chinese clients.
Looking more broadly, the US has also fractured its trading relationships with a range of other parties. We see the most elevated risk being the US trade relationships with the European Union, where the US has most recently threatened tariffs on the automobile and auto parts industries.
2. Industrial activity
Global industrial production and trade began slowing in 2018 and decelerated further in 2019, with weakness in motor vehicle manufacturing accounting for as much as a third of the slowdown in trade by IMF estimates.
Late in 2019, we began to see key data for the manufacturing sector stabilise and even start to rebound. While this may in part be due to a pause in the US-China trade war, in our view the bigger driver is that sentiment simply overshot to the downside.
There are therefore some signs that we may have reached an inflection point. This is especially important to Europe, and in particular Germany, which saw its economy contract in the second quarter after years of powering the Eurozone economy. Moving into 2020, it will be important for industrial growth to stabilise to avoid dragging down the service economy.
3. US labour markets
The US labour market has remained one of the brightest spots in the US economy, which has helped to keep recession fears at bay.
We believe there is a virtuous circle in which a stronger labour market leads to higher wage growth, which in turn leads to increased consumer spending, which then feeds back into job and wage growth.
While job growth in the US slowed in 2019, it remained at a level materially above that needed to keep pace with population growth. In 2020, we expect further slowing in the job growth numbers as employers find it more difficult to fill open positions and global growth remains sluggish.
Labour market data from the US is bearing this out – with a decline in the job opening rate from a high of 4.8 per cent at the beginning of 2019 to 4.4 per cent as at September. Still, we believe job growth will continue to exceed the number of jobs needed to maintain stable unemployment—about 80—-100,000 jobs per month. This should see the unemployment rate drop below 3.5 per cent and continue to put upwards pressure on wages in the US.
4. Global monetary policy
For perhaps the first time in a decade, 2020 might be a year in which monetary policy is not a key consideration. We expect central banks to remain on the sidelines for the foreseeable future.
In the US, the Federal Reserve Open Market Committee (FOMC) Chair Jerome Powell has made it clear that the Committee has no intention of either cutting rates beyond the current level of 1.5 per cent -1.75 per cent, barring a significant change in the economic outlook, or of raising them, barring a significant and sustained increase in inflation.
Market expectations for a number of other major central banks, such as the European Central Bank imply a similar outlook, with rates likely to remain on hold through 2020.
However, several major central banks may re-examine their strategies in light of the challenges posed by low rates, low inflation and slow growth. Regardless, we expect any shift in strategy to be communicated carefully, to mitigate the risk of market shocks.
5. Global technology ecosystem
While the technology sector juggernaut has dominated markets for the last decade, technology companies increasingly find themselves in policymakers’ crosshairs. The sector is under increasing scrutiny as concerns over data privacy, global taxation, market power, content moderation and the role of social media in politics all increasingly arouse passion and raise questions about the public interest.
At the same time, US national security concerns are increasingly leading to restrictions on Chinese technology. Conversely, China is increasingly motivated to accelerate its efforts to develop a sophisticated indigenous technology industry that is not susceptible to US trade restrictions.
Taking all of these factors into consideration, the operating landscape for technology companies appears to be much less certain than in the past.
6. US politics
Finally, it would be remiss not to mention the uncertainty arising from both the ongoing impeachment process and the US elections in 2020. However, investors often tend to overestimate the importance of the President and policy to the overall trajectory of the US economy.
It is also easy to overestimate the likelihood of large policy changes, which usually require single-party control of the White House, Senate and House of Representatives.
From the perspective of investors, the policy areas we believe should be most important in the near term are trade policy, for which the President has significant flexibility, along with corporate tax policy, and regulation of industries such as energy.
The investment outlook
Our view is that we are likely to experience slow growth, but no recession in 2020. We believe the global economic backdrop will continue to be challenging but our base case is that the global industrial slowdown will find a bottom without spilling over to the service sector.
Looking forward, we see modest upside for equities driven by earnings growth. However, we would caution that at this stage in the cycle, investors should take opportunities to upgrade the quality of their holdings, with a focus on valuation and fundamentals such as high returns on capital, strong balance sheets, and robust cash flow.
In fixed income markets, while we do not foresee a spike in defaults, investors should be wary of reaching for yield by taking on duration and credit risk.
In 2020, we believe security selection is likely to be a much more meaningful portion of total returns, as equity markets appreciation is likely to be capped in the mid-single digits and bond returns may well be even lower.