Americas CIO View

2020 outlook: a difficult year to value

S&P 500 target for 2020 yearend is 3300 with flat probabilities from 3100 to 3500

After careful consideration, our outlook for 2020 is to accept that anything might be possible. While always true, we think uncertainty for equity markets is high for 2020, both for 2020 end and the yearlong journey. This is despite good reasons to be confident in continued economic growth and other healthy macroeconomic conditions, such as employment. This is because the earnings outlook is more uncertain relative to gross domestic product (GDP) than usual and the potential change in earnings valuation is very uncertain from here. It is reasonable to expect stable price-to-earnings ratios (P/Es) and mid-single digit S&P 500 earnings-per-share (EPS) growth in 2020, but we view any S&P 500 price from 3100 to 3500 as equally possible or flatly distributed.

Fade clarity proclamations: most of 2019's concerns will probably return in January

Concerns about economic slowing, soft capital expenditures and manufacturing, excess oil production, low interest rates, Brexit uncertainties, U.S.-China trade, technological and geopolitical conflicts will probably remain in 2020; likely with unexpected flare-ups again. Our S&P 500 target, including the flat probabilities assigned to 3100 through 3500 assumes that President Trump is re-elected or that Democrats nominate a moderate candidate. Election concerns and political uncertainty will rise in our opinion in 2020, but will likely be relieved post elections.

For 2020, carefully assess your risk tolerance and gain/loss utility, diversify!

Low confidence in our expected return for 2020 is not from downside tail risks, we are not bearish. It is from flat or non-normally distributed probabilities for return scenarios around our base case. We do not see greater than usual tail-risk probabilities for a recession or bear-market losses, despite the U.S. election risk. But the flat probability distribution around our target P/E and return, along with a low single-digit expected return, could make a small loss for equity investors a higher than usual chance in 2020 despite an expected healthy economy, decent return, and no higher than usual bear-market risk. Investors must weigh if it is worth it. It is uncertain how they will respond.

20 themes for 2020:

  1. Record expansion continues, but the United States, China and Europe might slow in 2020 vs. 2019
  2. Low interest rates for longer: Global investors must take risk to earn real returns
  3. Muted inflation: Excess capacity + decent productivity gains = slow growth + low inflation
  4. Central banks seek new tools: Interest rates unlikely to rise much before next recession
  5. Flattish yield curve is the new norm: Yield curve will likely stay modestly positive or flattish
  6. U.S. dollar stable through U.S. election: Any EUR/USD gain likely to be modest
  7. Commodities need global acceleration, yet upside still capped: DWS West Texas Intermediate (WTI) estimate 54 U.S. dollars per barrel
  8. China tariffs rollback will probably be slow if at all: Tariffs still in Trump's policy toolbox
  9. Industrial excess capacity: Weak demand for commodities and manufactured goods
  10. U.S. Federal Reserve (Fed) balance sheet rising vs. liquidity: Liquidity trapped as large banks' excess reserves
  11. 2020 expected S&P 500 EPS 172 U.S. dollars: 5% year-over-year growth assuming a slow and modest reduction in tariffs
  12. Valuations: Target S&P 500 price-to-earnings ratio is 19.2, we see equal chances for 18 to 21
  13. Moderate EPS growth + high valuations = moderate future returns: 5% 2020 expected return
  14. Credit vs. equities: 2020's return / risk is probably better at investment-grade and high-yield credit than equity
  15. Chutes and Ladders: Trade policy, monetary policy, tax policy, geopolitical policy, elections
  16. Election 2020: A Trump or a moderate Democrat victory is probably neutral for the market
  17. Region/ size/ style tilts: More neutral on these tilts until further clarity to 2020 emerges
  18. Sector tilts: We adopt a barbell approach with most sectors at either overweight or underweight
  19. Triple-net returns: After fee, after tax, real returns likely to be above history for equities
  20. Allocators need active and passive to reach total-portfolio-return objectives: Potentially seek alpha strategies that work in the big asset-class segments, be tactical with exchange-traded-funds (ETFs)

 

Appendix: Performance over the past 5 years (12-month periods)

  11/14 - 11/15 11/15 - 11/16 11/16 - 11/17 11/17 - 11/18 11/18 - 11/19
S&P 500 2.7% 8.1% 22.9% 6.3% 16.1%
Past performance is not indicative of future returns.
Sources: Bloomberg Finance L.P., DWS Investment GmbH as of 12/20/19

 

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