Market Outlook: January 2020
Advanced economy central banks traveled back in time and returned to their easy monetary policies of the past in order to save their future economic expansions. Combined with easing U.S. — China trade tensions, this led to a powerful equity market rally in 2019 with the MSCI All Country World Index rising north of 20% year-to-date.
The global economy appears to be stabilizing. Risks may still be tilted to the downside, but we are not forecasting a global (or U.S.) recession in 2020. Citi’s economists think that global growth will settle in around 2.7% year-on-year in both 2020 and 2021 as global manufacturing activity rebounds. Trade tensions remain a risk with many details yet to be settled, but at least tensions are not rising as they were in early-to-mid 2019.
We think that the bull market remains intact and believe that global equities could return 6.0% to 8.0% in 2020. In the United States, Citi is looking for similar returns with a year-end S&P 500 target of 3,375. Sectors that are most sensitive to the economic cycle (or cyclicals) may have further room to run. However, we are viewing the back half of 2020 through a more defensive lens with the U.S. Presidential election quickly approaching.
The Federal Reserve has signaled that it will likely remain “on-hold” through 2020 and Citi’s economists agree. After hiking interest rates four times in 2018, the Fed has nearly unwound all of those rate hikes by cutting rates three times in 2019. Exactly three rate cuts is consistent with “insurance cuts” of the past (1995-1996 and 1998). We do not envision another rate cut, but the bar is set much lower for a cut than it is for a hike.
Global Economy: Bottoming Out?
There are early signs that growth may be stabilizing
The global economy and financial markets diverged greatly in 2019 with many regions of the world facing downside risks as global trade volumes slowed. This slowdown was felt acutely on the manufacturing side of the economy in many regions. Fortunately, there are some signs that global manufacturing activity may be starting to stabilize (see figure 1).
Barring a notable re-escalation of trade tensions, we expect the stabilization in manufacturing to lead to a bottoming out of global growth in the first half of 2020. According to Citi's economists, global growth should stabilize at around 2.7% year-on-year. In the United States, growth seems likely to advance by about 2.0% year-on-year as weak business investment continues to weigh on growth. With a phase-one trade agreement between the U.S. and China likely to be signed in early January, it is possible that business investment could rebound alongside business confidence (see figure 2). However, we think that rising tax policy uncertainty heading into the 2020 U.S. Presidential election may limit the potential upside.
Business confidence is likely to remain challenged in 2020
Away from the United States, Citi’s economists think that 2020 could be the year of upgrades to real GDP growth for the Euro Area (see figure 3). They see clear signs of stabilization and believe that a combination of continued fiscal policy support and constant monetary policy accommodation could lead to a pick-up in economic activity from the start of 2020 with GDP growth averaging around an annualized rate of about 1.4% by the end of 2020. In China, growth looks likely to slide further – falling from 6.2% in 2019 to 5.8% in 2020. Even with a phase-one trade deal, we think that exports will slow and continue to weigh on the region as some tariffs are expected to remain in place for the time being.
Global Stocks: Fears Fading
The coast is not entirely clear, but it is clearer
In the fourth quarter of 2018, global equity markets sent an alarming signal to policymakers with equities falling sharply as the Fed continued to signal additional rate hikes amid a backdrop of slowing global growth. Eventually, central banks in developed markets heeded that warning and returned to interest rate cuts in order to stave off a potential recession. This abrupt pivot from rate hikes to rate cuts, drove risk assets markedly higher across the board with most regions experiencing broad gains (see figure 4). As we suggested in early 2019, if an investor believes the old market adage that, “bull markets do not die of old age, central banks murder them,” then one must also consider that, “central banks can breathe life back into an aging bull market.”
In addition to easier monetary policy, trade policy uncertainty has been in decline with a phase-one deal between the U.S. and China likely to be signed in early January. A tabling of the tariffs that were scheduled to go into effect on December 15 and a partial roll back of existing tariffs on Chinese capital goods could imply that cyclical sectors like Industrials and sub-components indices like Semi-Conductors may have further room to run. Likewise, any rebound in growth would likely further re-steepen the yield curve, which could support Financials.
Away from trade policy, the 2020 U.S. Presidential election may also serve as a market catalyst with tax policy uncertainty likely to rise. However, we would remind investors that changes in the tax code requires Congress. In most cases, a unified Congress, which seems unlikely, given the current political landscape.
We would not be surprised to see increased market volatility ahead of the U.S. election (just as we did in 2016), but we are not ready to completely ignore the potential positives of an election year either. With most candidates desiring a strong economy during their term, we think that the election could actually support equities if discussions eventually turn to fiscal stimulus in the form of tax cuts 2.0 or infrastructure spending. The election will matter to financial markets, but it is not entirely clear to us that the upcoming election will materially damage equities (see figure 5). We discuss the election in more detail in the “Risks” section.
We are not expecting “2019-like” returns in 2020
Overall, we expect global equity markets to see further upside. However, we are not expecting “2019-like” returns in the year ahead. We think that returns in the 6.0% to 8.0% range for global equities seem much more likely than lofty double-digit returns. Citi’s Chief U.S. Equity Strategist Tobias Levkovich thinks that a reasonable year-end 2020 target for the S&P 500 is about 3,375 — which represents about a 5.5% gain from today’s levels. See our “Asset Class View” section for Citi’s preferences.
Global Fixed Income: So Low
Very low (and negative) yields pose a challenge globally
In order to arrest slowing economic growth globally, central banks reverted to policies of the past in order to the save their economic expansions. The side effect of this is that yields have been driven even lower with the total market value of negative yielding debt surging globally (see figure 6). As Citi’s Private Bank points out, globally, yields have fallen to about 1.6%. When the U.S. is excluded, yields are closer to just 0.6%.
While this trend has reversed a bit (as figure 6 shows), we suspect that this environment of lower rates will likely persist for some time as advanced economies continue to embrace monetary easing. In the United States, Citi’s economists are expecting the Fed to remain “on-hold” for some time. However, the key point for financial markets is that the Fed is now much more likely to serve as a tailwind than a headwind. The Fed has made quite clear through its communications that it remains ready to act to sustain the expansion if need be and is unlikely to raise rates unless it sees a notable uptick in inflation. This means that the hurdle rate for a pivot from rate cuts to rate hikes is set quite high (see figure 7).
We expect lower fixed income returns in the year ahead
With rates already so low globally, we think that fixed income returns may be lower in 2020 than in 2019 — perhaps in the range of 1.0% to 2.0%. Regionally, fixed income assets in Japan and Europe look the most risky to us with negative yields prevalent across the regions. As a result, Citi’s Private Bank is maintaining a deep underweight on sovereign debt within those regions. However, that does not mean that there are not pockets of opportunity.
In the U.S., the Global Investment Committee maintains overweights on short-, intermediate-, and long-duration U.S. Treasuries as well U.S. Treasury Inflation-Protected Securities (or TIPS). We also believe U.S. intermediate-duration investment grade corporate debt may outperform as investors continue to search for yield. For U.S.-based investors, municipals with solid taxable-equivalent yields present an opportunity in longer-term maturities in some states. Away from the U.S., other preferences include emerging markets debt, which we see as offering value over U.S. high yield corporates.
Risks: Policy and Politics
Trade tensions may fade as tax policy uncertainty rises
Even though equity markets surged in 2019, that does not imply that there were no risks. In fact, we would argue that it was risk that ultimately drove markets higher. If financial markets did not send a signal to policymakers about the potential for a U.S. recession due to tightening Fed policy and U.S. — China trade tensions, the Fed likely would not have reversed its stance from additional rate hikes to rate cuts. Without this reversal, financial markets like would not have had such powerful returns in 2019 (see figure 8).
Looking ahead, we think the risks of an overly aggressive Fed and U.S. — China trade tensions have faded, but there are still some risks to consider. Among them is the unique timing of the U.S. Presidential election as it may coincide with a patch of economic sluggishness. Clearly, many things can change between now and then, but leading economic indicators like the brief inversion of the yield curve and some tightening in credit conditions for commercial and industrial firms point to the potential for some economic weakness in the second half of 2020. Combined with concerns about a potential change in tax policy and tighter business regulation should the White House flip, this could lead to some market volatility in the back half of 2020. However, we encourage investors to try to keep their emotions about politics in check when it comes to their investments for several reasons. One, we are not yet certain who the final Democratic candidate will be. Two, large changes in tax policy require the approval of Congress which more likely than not will once again be under divided leadership. And three, as Citi Private Bank points out in the their outlook, we think it’s important to note that U.S. voters have re-elected the incumbent president in 10 out of 13 elections (or 77% of the time) over the past century. In the last 50 years, the incumbent has won 6 out of 8 elections (or 75%).
Historically, positive economic conditions have led to the reelection of the incumbent. As figure 9 shows, recent polling suggests that the public views the government’s stewardship of economic policy quite favorably right now. This differs noticeably from the conditions under which President Carter and President Bush Senior were running for re-election and lost.
It is possible that “this time is different” with many voters suggesting that the economy is not the main driver of their voting intentions, but history suggests to us that calls for extreme market movements due the election are as likely to be misplaced as they were in 2016.
We think that the economy is the primary driver of market performance, not Washington.
Citi Private Bank’s Asset Class Views
|Asset Class: Fixed Income||View||Investment Rationale|
|U.S. Large Cap||Overweight||U.S. equities have been more resilient amid trade risks relative to their global counterparts. The Federal Reserve has shown its willingness to cushion the economy, helping to keep equity markets broadly supported. EPS should rise 7% in the coming year on a rebound in trade and industrial production after exaggerated declines in 2019.|
|European Large Cap||Overweight||Cheap valuations, lower Italian political risks, and a potential U.S.-China trade deal are positives. Tentative signs of stabilization in the manufacturing sector are also a positive as Europe is highly reliant on exporting capital goods.|
|Japan Large Cap||Overweight||The impact of the latest round of consumption tax hikes is likely to be less severe than the 2014 episode. In addition, there has been a gradual shift occurring towards more shareholder-friendly policies. Dividend yields and return on equity are converging to levels seen in other markets.|
|Developed Market Small and Mid-Cap (SMID)||Neutral||In the near-term, small-caps may benefit from a cyclical upswing and rebound in the global manufacturing sector. Longer-term, we maintain a preference for higher quality, large-cap names who may be more resilient to potential headwinds down the road.|
|Emerging Asia||Overweight||Trade, Fed policy, and Chinese domestic reflation are the key forces which will impact Asian and broader EM equities in the months ahead. A trade resolution could lead to a rebound in cyclical shares.|
|Emerging EMEA||Underweight||EM EMEA (Europe, Middle East, and Africa) will likely be supported ahead with some green shoots emerging, driven by improving domestic economic outlooks, better investor sentiment globally, and lowering global trade risk. However, similar to broader EM markets, idiosyncratic risks at the country level remain, especially in areas such as South Africa. We believe Asia ranks higher as a regional opportunity.|
|Emerging Latin America||Neutral||Slow growth and high fiscal deficits are structural negative risks for Latin America, while financial conditions represent the next largest risks. As negative expectations are baked into economic forecasts, even marginally positive data can have large upside surprises. We remain neutral on the region across all countries.|
|Asset Class: Fixed Income||View||Investment Rationale|
|U.S. Sovereign Bonds||Overweight||The Fed’s monthly purchases of T-Bills are likely to keep short rates anchored, while a rebound in manufacturing and easing trade tensions may help long-dated yields rise. That said, dovish central bank policies around the world might limit how far yields can ultimately rise. For taxable U.S. investors, municipals with 3-4% taxable-equivalent yields remain a strong opportunity.|
|European Sovereign Bonds||Underweight||European Central Bank asset purchases are likely to keep rates low while having a positive impact on euro spreads; However, we continue to avoid negative yielding bonds that offer zero coupon protection when interest rates move higher, pushing down bond values.|
|Emerging Market (EM) Sovereign Bonds||Overweight||U.S. dollar-denominated emerging market debt still offers some of the best relative value in global fixed income. We stress the importance of global diversification when investing in EM, as idiosyncratic events occur from time to time. In local-currency denominations, yields have fallen to extremely low levels. Persistent U.S. dollar strength may continue to weigh on unhedged returns.|
|Corporate Investment Grade||Overweight||In the U.S., risks to future performance are likely more tied to rising rates than wider spreads. For investors overweight cash, we still favor extending duration to intermediate maturities, where spreads curves are steep. In Europe, European Central Bank corporate bond purchases are expected to support tight spreads.|
|Corporate High Yield||Neutral||In the U.S., high-yield bonds look rich, though single-B credit-rated issues appear cheap to double-B credit rated issues. In Europe, technical support from European Central Bank purchases is likely be strong, while yields are higher than most in the region.|
Forecasts, Indicators, and Returns
|Region||GDP Growth||CPI Inflation||10-Year Yields||Exchange Rate vs. USD|
|Global: Based on PPP Weights||3.1||3.3||3.6||3.2||3.3||3.1||N/A||N/A||N/A||N/A||N/A||N/A|
|Early Returns (%)||Valuations||Dvd Yield|
|Equity Index||Level||2014||2015||2016||2017||2018||Month to Date||Quarter to Date||Year to Date||Price to Earnings||12-Month Forward P/E Ratio||Current (%)|
|Fixed Income Returns (%)||Other Key Rates|
|Bond Index||Yield to Maturity||2013||2014||2015||2016||2017||Month to Date||Quarter to Date||Year to Date||Instrument||%|
|Global||1.37||7.9||0.9||3.3||2.1||0.5||-0.3||-0.5||7.5||10 Year U.S.||1.78|
|U.S.||2.32||5.9||0.5||2.7||3.6||0.0||0.0||0.3||8.9||Treasury 30 Year U.S.||2.21|
|Europe||0.12||11.2||1.1||3.3||0.5||0.5||-0.6||-1.5||6.8||Treasury 1 Year CD Rate||1.14|
|EM Sovereign||5.24||7.1||0.6||9.6||9.8||-4.1||-0.2||-0.2||12.2||30 Year Fixed Mortgage||3.73|
|U.S. High Yield||6.36||1.8||-5.6||17.8||7.0||-2.1||0.5||0.7||11.8||Prime Rate||4.75|
|Region / Index||Year-to-Date Return|
|United States (S&P 500)||25.3%|
|Euro (Euro STOXX 50)||19.0%|
|EM Government Bond||12.2%|
|U.S. High Yield||11.8%|
|U.S. Investment Grade||8.9%|
|Emerging Markets (MSCI)||7.7%|
|Euro Investment Grade||6.8%|
|Economic Sectors||Year-to-Date Return|
- The Citi Emerging Market Sovereign Bond Index (ESBI)
- includes Brady bonds and US dollar-denominated emerging market sovereign debt issued in the global, Yankee and Eurodollar markets, excluding loans. It is composed of debt in Africa, Asia, Europe and Latin America. We classify an emerging market as a sovereign with a maximum foreign debt rating of BBB+/Baa1 by S&P or Moody's. Defaulted issues are excluded.
- The Citi U.S. Broad Investment-Grade Bond Index (USBIG)
- racks the performance of US Dollar-denominated bonds issued in the US investment-grade bond market. Introduced in 1985, the index includes US Treasury, government sponsored, collateralized, and corporate debt providing a reliable representation of the US investment-grade bond market. Sub-indices are available in any combination of asset class, maturity, and rating.
- The Citi World Broad Investment Grade Bond index
- is weighted by market capitalization and includes fixed rate Treasury, government sponsored, mortgage, asset backed, and investment grade (BBB–/Baa3) issues with a maturity of one year or longer and a minimum amount outstanding of $1 billion for Treasuries, $5 billion for mortgages, and $200 million for credit, asset-backed and government-sponsored issues.
- Corporate High Yield
- is measured against the Citigroup US High Yield Market Index, which includes all issues rated between CCC and BB+. The minimum issue size is $50 million.All issues are individually trader priced monthly.
- Corporate Investment Grade
- is measured against the Citi World Broad Investment Grade Index (WBIG) – Corporate, a subsector of the WBIG. This index includes fixed rate global investment grade corporate debt within the finance, industrial and utility sectors, denominated in the domestic currency. The index is rebalanced monthly.
- Developed Market Large Cap Equities
- are measured against the MSCI World Large Cap Index. This is a free-float adjusted, market-capitalization weighted index designed to measure the equity market performance of the large cap stocks in 23 developed markets. Large cap is defined as stocks representing roughly 70% of each market’s capitalization.
- Developed Market Small- and Mid-Cap Equities
- are measured against the MSCI World Small Cap Index, a capitalization-weighted index that measures small cap stock performance in 23 developed equity markets.
- Developed Sovereign
- is measured against the Citi World Government Bond Index (WGBI), which consists of the major global investment grade government bond markets and is composed of sovereign debt, denominated in the domestic currency. To join the WGBI, the market must satisfy size, credit and barriers-to-entry requirements. In order to ensure that the WGBI remains an investment grade benchmark, a minimum credit quality of BBB–/Baa3 by either S&P or Moody's is imposed. The index is rebalanced monthly.
- Dow Jones Industrial Average (DJIA)
- is a price-weighted average of 30 significant stocks traded on the New York Stock Exchange (NYSE) and the NASDAQ.
- Emerging Markets Equities
- are measured against the MSCI Emerging Markets Index, which is free-float adjusted and weighted by market capitalization. The index is designed to measure equity market performance of 22 emerging markets.
- Emerging Sovereign
- is measured against the Citi Emerging Market Sovereign Bond Index (ESBI). This index includes Brady bonds and US dollar-denominated emerging market sovereign debt issued in the global, Yankee and Eurodollar markets, excluding loans. It is composed of debt in Africa, Asia, Europe and Latin America. We classify an emerging market as a sovereign with a maximum foreign debt rating of BBB+/Baa1 by S&P or Moody's. Defaulted issues are excluded.
- The Euro Broad Investment-Grade Bond Index (EuroBIG)
- is a multi-asset benchmark for investment-grade, Euro-denominated fixed income bonds. Introduced in 1999, the EuroBIG includes government, government-sponsored, collateralized, and corporate debt.
- Europe Ex UK Equities
- are measured against the MSCI Europe ex UK Large Cap Index, which is free-float adjusted and weighted by market capitalization. The index is designed to measure the performance of large cap stocks in each of Europe’s developed markets, excluding the United Kingdom.
- The EURO STOXX 50 Index
- covers 50 blue-chip stocks from 12 Eurozone countries: Austria, Belgium, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, the Netherlands, Portugal, and Spain.
- Fed Funds Rate
- is the rate at which depository institutions (banks) lend reserve balances to other banks on an overnight basis. Reserves are excess balances held at the Federal Reserve to maintain reserve requirements. The fed funds rate is one of the most important interest rates in the U.S. economy since it affects monetary and financial conditions, which in turn have a bearing on critical aspects of the broad economy including employment, growth, and inflation. The Federal Open Market Committee (FOMC) that meets eight times a year, sets the fed funds rate, and uses open market operations to influence the supply of money to meet the target rate.
- Global Bonds
- are measured against the Citigroup Broad Investment Grade Bond. The index is weighted by market capitalization and includes fixed rate Treasury, government sponsored, mortgage, asset backed, and investment grade (BBB–/Baa3) issues with a maturity of one year or longer and a minimum amount outstanding of $1 billion for Treasuries, $5 billion for mortgages, and $200 million for credit, asset-backed and government-sponsored issues.
- Global Equities
- are measured against the MSCI All Country World Index, which represents 48 developed and emerging equity markets. Index components are weighted by market capitalization.
- Gross Domestic Product
- is the total value of goods produced and services provided in a country during one year.
- The High-Yield Market Index
- is a US Dollar-denominated index which measures the performance of high-yield debt issued by corporations domiciled in the US or Canada. Recognized as a broad measure of the North American high-yield market, the index includes cash-pay, deferred-interest securities, and debt issued under Rule 144A in unregistered form. Sub-indices are available in any combination of industry sector, maturity, and rating.
- Leading Economic Indicators
- are measurable economic factors that change before the economy starts to follow a particular pattern or trend. Leading indicators are used to predict changes in the economy, but they are not always accurate.
- MSCI All Country World Index
- captures all sources of equity returns in 23 developed and 23 emerging markets.
- MSCI Emerging Markets Index
- reflects performance of large and mid-cap stocks in roughly 20 emerging markets.
- MSCI Japan Large Cap Index
- is a free-float-adjusted market-capitalization-weighted index designed to measure large-cap stock performance in Japan.
- The NASDAQ
- is a composite index is a market-capitalization weighted index of more than 3,000 common equities listed on the Nasdaq stock exchange.
- The Nikkei 225
- is Japan’s leading index. It is a price-weighted index comprised of Japan’s top 225 blue-chip companies on the Tokyo stock exchange.
- Price-to-Earnings Ratio (P/E ratio)
- is the ratio for valuing a company that measures its current share price relative to its per-share earnings. The price-earnings ratio is also sometimes known as the price multiple or the earnings multiple. The P/E ratio can be calculated as: Market Value per Share / Earnings per Share.
- S&P 500 Index
- is a capitalization-weighted index, which includes a representative sample of 500 leading companies in leading industries of the US economy. Although the S&P 500 focuses on the large cap segment of the market, with over 80% coverage of US equities, it is also an ideal proxy for the total market.
- The Unemployment Rate
- is a measure of the prevalence of unemployment and it is calculated as a percentage by dividing the number of unemployed individuals by all individuals currently in the labor force. During periods of recession, an economy usually experiences a relatively high unemployment rate.