by Bill O’Grady & Mark Keller
Summary – The Base Case:
- Economy grows at 1.5%; consumption has become the primary driver of growth.
- Expansion continues to set new records for duration; no recession is our base case in 2020, although there are increasing risks of a downturn.
- Core inflation max is 2.5% next year.
- 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.
- S&P 500 earnings for 2020 will be $174.91 on a Thomson/Reuters basis (6.00% of GDP).
- Assuming a P/E of 19.3x, using the S&P earnings projection, our expectation for the S&P 500 is 3375.76.
- We expect some improvement in the lower capitalization areas of the equity markets, tempered by slower economic growth.
- 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.
- International will benefit if our assumption that the dollar weakens is correct.
- We expect mostly steady monetary policy next year.
- We expect the 10-year yield to peak at 2.25% next year, with a range of 1.70% to 2.25%.
- Investment-grade bond spreads should stabilize; we believe high-yield bonds are overvalued and no more than a benchmark weighting is justified.
- Despite a weaker dollar, commodities will likely struggle due to slow global growth.
Risks to the Forecast:
- 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.
- Secondary risk – Election: Election years add an element of uncertainty to investment. This year’s election is fraught with potential risk.
- 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.