by Bill O’Grady & Mark Keller | PDF

Summary – The Base Case:

1. Economy grows at 1.5%; consumption has become the primary driver of growth.
2. Expansion continues to set new records for duration; no recession is our base case in 2020, although there are increasing risks of a downturn.
3. Core inflation max is 2.5% next year.
4. Dollar weakens, although the direction is mostly dependent on administration trade policy. We expect preparations for the 2020 elections will lead to a less aggressive trade policy.
5. S&P 500 earnings for 2020 will be $174.91 on a Thomson/Reuters basis (6.00% of GDP).
6. Assuming a P/E of 19.3x, using the S&P earnings projection, our expectation for the S&P 500 is 3375.76.
7. We expect some improvement in the lower capitalization areas of the equity markets, tempered by slower economic growth.
8. Growth has greatly outperformed value in recent years, a trend that has been mostly driven by multiple expansion. While we are expecting only a modest multiple expansion next year, continued outperformance by growth stocks is probable.  This long period of outperformance, however, is likely nearing its end.  Given the difficulty of timing such a transition, we recommend a balanced position in value/growth.
9. International will benefit if our assumption that the dollar weakens is correct.
10. We expect mostly steady monetary policy next year.
11. We expect the 10-year yield to peak at 2.25% next year, with a range of 1.70% to 2.25%.
12. Investment-grade bond spreads should stabilize; we believe high-yield bonds are overvalued and no more than a benchmark weighting is justified.
13. Despite a weaker dollar, commodities will likely struggle due to slow global growth.

Risks to the Forecast:

1. Primary risk – Recession: The Federal Reserve has lowered rates recently and this action may bring us a soft landing. However, recession risks are elevated.  We provide market risk parameters below should a recession occur.
2. Secondary risk – Election: Election years add an element of uncertainty to investment. This year’s election is fraught with potential risk.
3. Secondary risk – Melt-up: Ample liquidity, accommodative monetary policy and fairly valued equity markets could trigger a sharp rise in equity prices, especially if the markets become comfortable with the idea that the Fed has engineered a soft landing. Under this scenario, we provide possible upside parameters below.

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