So far the new century has been a tale of two decades. During the first decade, economic recession and market volatility caused investors nothing but indigestion. But for all the temporary tumult over the past ten years, we never experienced a recession. It’s the first time that’s happened in modern history. Fiscal and monetary policy solutions have served to quell financial market volatility and flattered returns of risk assets.
As another new decade dawns, 2019 is going out with a bang! Major US stock benchmarks are at all-time highs. Tight credit market spreads mean borrowing is easy and cheap. And measures of market volatility plumb low levels under sunny skies.
All that signals serenity ahead. However, in 2020 the margin for error—and for opportunity—will likely be as small as it’s been in a very long time.
Nothing but Blue Skies?
Looking beyond 2019’s gratifying investment returns, it’s tough to understand why investors are so optimistic. Populist anger is rising across the globe. Economic growth and corporate profits peaked more than eighteen months ago, even as financial assets continued to reach new heights. With three Federal Reserve rate cuts bolstering future expectations, investors aggressively bid up shares. Further dissecting stock returns suggests that multiple expansion—investors’ willingness to pay higher prices today for future growth—has driven all the returns.
Additionally, despite some signs of progress, so far US-China trade negotiations have been all talk and no action. Yet investors still have a tremendous amount of faith that a deal will be reached by the end of this year to reaccelerate global economic growth and corporate profits. Too much faith, perhaps. A watered down trade deal isn’t likely to be the silver bullet that investors have banked on.
Like the trade negotiations, in many respects, the investment landscape is shifting from tell me something good to show me something good.
Eye of the Storm
Evaluating risks in 2020 also raises the question of whether the US consumer, the economy’s engine of growth, can keep spending like it’s 2019. With today’s lower taxes, massive gains in financial assets, robust job market and falling interest rates, it’s difficult to imagine a more pro-consumer environment. In fact, consumer strength is the primary reason that the US economy hasn’t succumbed to recession.
Yet, while generally about two-thirds of the US economy is driven by personal consumption, a rare shift is under way. The Bureau of Economic Analysis reported that third quarter US GDP growth was driven completely by personal consumption. Of course, falling corporate profits, additional tariffs scheduled for mid-December and Fed rate cuts likely on hold for a little while may make it tough for the consumer to continue to shoulder this larger burden.
Job gains and wage growth have started to slow, too. And while consumer sentiment measures remain elevated, they are trending lower. The last bastion of American economic strength might be showing signs of fatigue.
The consumer’s mood could also be soured by all the bluster surrounding the 2020 election. Public impeachment hearings have already started and politics have rarely been this divisive. Hard to believe. Notably, headlines trumpeting the misguided notion that this is a make or break election could keep some investors on the sidelines until the political outcomes are known.