2020 vision – growth up, returns still good

• Global shares saw strong gains as markets recovered from their 2018 slump, bond yields fell making shares very cheap and monetary conditions eased. This was despite several trade related setbacks along the way.
• Emerging market shares did well but lagged given their greater exposure to trade and manufacturing and a still rising $US along with political problems in some countries.
• Australian share prices finally surpassed their 2007 record high thanks to the strong global lead, monetary easing and support for yield sensitive sectors from low bond yields.
• Government bonds had strong returns as bond yields fell as inflation and growth slowed, central banks cut rates and quantitative easing returned.
• Real estate investment trusts were strong on the back of lower bonds yields and monetary easing.
• Unlisted commercial property and infrastructure continued to do well as investors sought their still relatively high yields. However, Australian retail property suffered a correction.
• Commodity prices rose with oil & iron up but metals down.
• Australian house prices fell further into mid-year before rebounding as the Federal election removed the threat to negative gearing & the capital gains tax discount, the RBA cut interest rates and the 7% mortgage test was relaxed.
• Cash and bank term deposit returns were poor reflecting new record low RBA interest rates.
• The $A fell slightly with lower interest rates & a strong $US.
• Reflecting strong gains in most assets, balanced superannuation funds look to have seen strong returns.
  

2020 vision – growth up, returns still good

The global slowdown still looks like the mini slowdowns around 2012 and 2015-16. Business conditions indicators have slowed but remain far from GFC levels. See next chart.

Source: Bloomberg, IMF, AMP Capital

While the slowdown has persisted for longer than we expected – mostly due to President Trump’s escalating trade wars – a global recession remains unlikely, barring a major external shock. The normal excesses that precede recessions like high inflation, rapid growth in debt or excessive investment have not been present in the US and globally. While global monetary conditions tightened in 2018, they remained far from tight and the associated “inversion” in yield curves has been very shallow and brief. And monetary conditions have now turned very easy again with a significant proportion of central banks easing this year. See chart. The big global themes for 2020 are likely to be:

• A pause in the trade war but geopolitical risk to remain high. The risks remain high on the trade front - but the Phase 1 US trade deal with China is consistent with a desire by President Trump to de-escalate trade tensions in 2020 to reduce the risk to the US economy knowing that if he lets it slide into recession and/or unemployment rise he likely won’t get re-elected. A “hard Brexit” is also unlikely albeit risks remain. That said geopolitical risks will remain high given the rise of populism and continuing tensions between the US & China and escalating tensions with Iran. In particular, the US election will be an increasing focus if a hard-left candidate wins the Democrat nomination.
• Global growth to stabilise and turn up. Global business conditions PMIs have actually increased over the last few months suggesting that monetary easing may be getting traction. Global growth is likely to average around 3.3% in 2020, up from around 3% in 2019. Overall, this should support reasonable global profit growth.
• Continuing low inflation and low interest rates. While global growth is likely to pick up it won’t be overly strong and so spare capacity will remain. Which means that inflationary pressure will remain low. In turn this points to continuing easy monetary conditions globally, with some risk that the Fed may have a fourth rate cut.
• The US dollar is expected to peak and head down. During times of uncertainty and slowing global growth like over the last two years the $US tends to strengthen partly reflecting the lower exposure of the US economy to cyclical sectors like manufacturing and materials. This is likely to reverse in the year ahead as cyclical sectors improve.
  

In Australia, strength in infrastructure spending and exports will help keep the economy growing but it’s likely to remain constrained to around 2% by the housing construction downturn, subdued consumer spending and the drought. This is likely to see unemployment drift up, wages growth remain weak and underlying inflation remain below 2%. 

With the economy remaining well below full employment and the inflation target, the RBA is expected to cut the official cash rate to 0.25% by March, & undertake quantitative easing by mid-year, unless the May budget sees significant fiscal stimulus. Some uptick in growth is likely later in the year as housing construction bottoms, stimulus impacts and stronger global growth helps.

Implications for investors

Improved global growth and still easy monetary conditions should drive reasonable investment returns through 2020 but they are likely to be more modest than the double-digit gains of 2019 as the starting point of higher valuations and geopolitical risks are likely to constrain gains & create some volatility:

• Global shares are expected to see returns around 9.5% helped by better growth and easy monetary policy.
• Cyclical, non-US and emerging market shares are likely to outperform, particularly if the US dollar declines and trade threat recedes as we expect.
• Australian shares are likely to do okay but with returns also constrained to around 9% given sub-par economic & profit growth.
• Low starting point yields and a slight rise in yields through the year are likely to result in low returns from bonds.
• Unlisted commercial property and infrastructure are likely to continue benefiting from the search for yield but the decline in retail property values will still weigh on property returns.
• National capital city house prices are expected to see continued strong gains into early 2020 on the back of pent up demand, rate cuts and the fear of missing out. However, poor affordability, the weak economy and still tight lending standards are expected to see the pace of gains slow leaving property prices up 10% for the year as a whole.
• Cash & bank deposits are likely to provide very poor returns.
• The $A is likely to fall to around $US0.65 as the RBA eases further but then drift up a bit as global growth improves to end 2020 little changed.
  

What to watch?

The main things to keep an eye on in 2020 are as follows:

• The US trade wars – we are assuming some sort of de-escalation in the run up to the presidential election, but Trump is Trump and often can’t help but throw grenades.
• US/Iran tensions – which could escalate further, potentially disrupting oil supplies.
  
• US politics: the Senate is unlikely to remove Trump from office following the House vote to impeach him but the issue could cause volatility as could the US election if a hard-left Democrat gets up (albeit unlikely).
  
• A hard Brexit looks like being avoided but watch UK/EU free trade negotiations through the year.
• Global growth indicators – like the PMI shown in the chart above need to keep rising.
• Chinese growth – a continued slowing in China would be a major concern for global growth.
• Monetary v fiscal stimulus in Australia – significant fiscal stimulus could head off further RBA rate cuts and quantitative easing.