OUTLOOK 2020: 7 Key Questions Answered

The opinions, projections and data are as of the date of this article and subject to change.

AT THE START OF A NEW YEAR AND NEW DECADE, the world seems poised on the edge of change. While the U.S. is experiencing the longest period of economic expansion ever recorded—10 years and counting—investors are apprehensive about trade, geopolitics and low growth, both at home and overseas. Meanwhile, powerful technological and demographic shifts could signal a wave of changes for the global economy. The Chief Investment Office (CIO) at Bank of America remains optimistic about the opportunities they see ahead. Here, they shed light on what 2020 could bring for the markets and the economy. For a more detailed analysis of their forecasts, read the 2020 Year Ahead: A World in Transition.

What do you see as some of the biggest opportunities for the markets in 2020—and what should investors watch out for?

Chris Hyzy, Chief Investment Officer, Merrill and Bank of America Private Bank

We believe the world is in transition, and 2020 will be a foundational year. First, we’re now back to a monetary policy that should allow the economy and inflation to run a little hotter than they have recently. The second element in transition is global trade: All eyes are on the U.S.-China trade negotiations, but trade around the world is shifting from globalized to localized. This shift will lead to increased automation and technology use, which may mean higher initial costs, but should lead to increased productivity over the next business cycle. As a result, we believe that we’ll see two global supply chains emerge—one dominated by the U.S., the other by China. Third, we expect increased innovation across all sectors, especially when it comes to data speed and information storage, as well as the build-out and redevelopment of global infrastructure.

“We expect increased innovation across all sectors, especially when it comes to data speed and information storage, as well as the build-out and redevelopment of global infrastructure.”

Finally, in 2020 the Millennial generation will begin entering their top earning years, when their discretionary spending switches toward owning a home, building a family and buying things that they didn’t need before. That will lend itself over the next decade to the creation of the next great equity culture, similar to that of the 1980s and ‘90s.

We see three potential scenarios for the markets in 2020: a so-called ‘melt-up’ scenario, which could significantly benefit riskier assets, like equities; a balanced view that mixes growth optimism with election uncertainty over the summer; and a negative performance scenario where growth falters and geopolitical risks rise. Our base case is the balanced view.

U.S. stocks have been on a sustained upward trend for more than a decade now. Can they continue moving higher? What sectors look most promising?

Niladri Mukherjee, Head of Portfolio Strategy, Chief Investment Office, Merrill and Bank of America Private Bank

U.S. stocks can continue to advance, though we expect the path forward to be choppy and the nature of the gains will be different. In 2019, earnings growth was essentially flat, so the strong market we saw was mainly due to a significant expansion in price-to-earnings ratios. In 2020 we should see the reverse, with price-to-earnings potential expansion largely flat or perhaps slightly higher, and earnings growth of about 8%, leading to a fair value level for the S&P 500 of about 3,300, in our opinion.

Accommodative monetary policy from the Federal Reserve, a significant reason for last year’s advance, should continue to serve as a tailwind for U.S. stocks. At the same time, though, there remain two big unknowns that could lead to volatility. The biggest is what is going to happen with the U.S.-China trade relationship. The second is the uncertainty around next November’s U.S. election.

In terms of the kinds of stocks we favor, we’re still optimistic about U.S. equities over international—but with increasing interest in international—and we have a bias toward high quality and large-cap equities.

As far as U.S. sectors go, it’s hard to find anything that’s cheap when markets are reaching all-time highs. But financial services stocks are trading at reasonable valuations and should be helped by a steepening yield curve and productivity enhancements. With our optimistic view on consumer spending, consumer discretionary stocks should also do well. And as the global manufacturing cycle stabilizes and improves, select industrials are also worth considering.

Events in Washington feel like a fairly big risk factor this year. Has the market already taken that into account, or is it smart to hedge against potential market reactions?

Marci McGregor, senior investment strategist, Chief Investment Office, Merrill and Bank of America Private Bank

It’s still early, and markets aren’t yet super focused on next fall’s election. Typically, as the general election draws closer, say from August through November, both policy uncertainty and market volatility begin to rise. This time around, there are some big ideas on the table, so uncertainty is already pretty elevated. This winter, as primary season heats up, markets could really start paying attention.

As we get closer to the election, there are a few things financial markets will really care about, including candidates’ positions on tax and trade policies and regulation.

Historically, stocks have produced average returns of nearly 11% in presidential election years, and the market has risen almost nine out of 10 times.

For most investors whose time horizon isn’t the end of 2020, it’s important to take a step back and look at the market through a wider, longer-term lens. At the end of the day, markets care most about growth. They care about what consumers are doing and they care about corporate earnings. In the coming year, just like every other year, it’s the fundamentals that are going to drive the market. A lot of the rest of what you hear is just noise.

What do you see as the biggest geopolitical hotspots in 2020?

Joseph Quinlan, Head of CIO Market Strategy, Chief Investment Office, Merrill and Bank of America Private Bank

Uncertainty around the U.S.-China trade relationship is a big one. It continues to affect global trading volumes, countries that are trade-dependent, and multinationals with extensive global supply chains. Another big issue is the technology cold war emerging between the U.S. and China around what systems will be used and whether countries will be forced to choose one over the other.

Brexit is still on everyone’s minds and additional factors have extended the uncertainty, including the British government’s inability to reach a deal with the European Union in 2019. But as sloppy as this process has been, much of it has already been priced into financial assets.

There is also always the risk of unexpected events in places like the Middle East. The U.S. has some degree of geopolitical security there, because it is now the world’s largest producer of crude oil. But oil is a global commodity, and unexpected price hikes in places like Japan or China would reduce demand, which in turn can lead to weaker global growth.

But the greatest geopolitical risk for U.S. investors is the looming presidential election. We believe the key in all of this is to stay focused on the issues that matter to growth: The policy backdrop, fiscal expansion, monetary easing, earnings growth and secular long-term themes, including demographic trends like global aging and longevity. In many cases, geopolitical risks could even create opportunities for investors who can tune out the noise and keep their nerves steady.

What’s the outlook for emerging market economies in 2020?

Ehiwario Efeyini, senior market strategy analyst, Chief Investment Office, Merrill and Bank of America Private Bank

Given China’s significant weighting within emerging markets, the key risk factor will be the trade conflict with the U.S. The frictions are not just about trade and investment, but also about China’s rise as a global power in areas like artificial intelligence, semiconductor design and electric vehicles—while its economy, though decelerating, is still growing in size. This will likely make for ongoing strategic competition between the two countries. Meanwhile, some exporters in industries like consumer electronics and textiles have been moving production away from China into other parts of Asia, and other emerging markets such as Indonesia, Thailand, Malaysia and Vietnam may benefit.

Elsewhere, economic and political turmoil in the Middle East poses risks to individual countries, but the region only accounts for a small share of the emerging market index, and so should not have a major impact in aggregate. We’ve also seen unrest in Latin America, but crucially not in Brazil and Mexico, which together are close to 90% of regional market cap.

Despite these challenges, the Brookings Institute projects that there will be around another 2 billion middle-class consumers entering the emerging world over the next decade. That could mean that sectors will matter more than geography when it comes to future returns. Areas such as consumer discretionary, healthcare and technology are tied to the long-term rise of the emerging market consumer class—a trend that we don’t see changing, even with the trade concerns. And emerging market valuations look relatively cheap compared to past levels, which suggests outperformance over the longer term.

The Federal Reserve switched course over the past year from a policy of raising interest rates to one of lowering them. Could the Fed continue on this path in 2020—and how could that affect savers and borrowers?

Matthew Diczok, fixed income strategist, Chief Investment Office, Merrill and Bank of America Private Bank

The Federal Reserve has said repeatedly that its goal is to continue the long economic expansion, and that was its motivation for changing course in 2019. With economic activity slowing, it began cutting rates in July, and there have been signs the economy is responding. Rate-sensitive sectors, including housing and autos, are beginning to rebound. And unless inflation increases significantly, the Fed has signaled that it’s unlikely to raise rates. So, while we don’t expect any rate cuts imminently, if there is any change in short term policy rates, it will likely be a reduction.

We think investors should worry less about what the Fed may do meeting-by-meeting, and instead remember that its current goal is to keep the economic expansion going. That’s generally helpful for the stock market and for investor portfolios overall. Both equity and fixed-income investments did phenomenally well in 2019 in our opinion.

But the lower rate environment continues to be very hard on savers and anyone looking for income, and that’s not likely to change significantly in 2020. Not long ago, the 10-year Treasury yielded over 3%, and high-quality corporate bonds yielded close to 4%. In retrospect, those were good opportunities, but some investors waited for higher yields. Now the 10-year Treasury is again below 2%—less than the inflation rate.

We recommend investing with a combination of short-, medium- and long-term bonds. The shorter-dated bonds let you reinvest at higher rates if yields rise, while the longer-term bonds will increase more in price if yields decline. But even at what seem like low yields, it makes sense to put your money to work sooner rather than later and let compounding do the work. If you persistently wait for higher rates, you could be waiting a long time—and foregoing additional income along the way.

Despite the continued strength in the U.S. economy, there are worries a recession could be ahead. What signs are you watching for in 2020 that growth will remain on track?

Jonathan Kozy, senior macro strategist, Chief Investment Office, Merrill and Bank of America Private Bank

Going into 2020, we do expect growth to slow to around 1.7% on an annual basis. That’s below growth in 2019, and slower than the 2.3% average during this 10-plus-year expansion.

Uncertainty from the trade war and U.S. elections in the fall will continue to weigh on business investment and certain other parts of the economy. Still, recessions are common in the first year of the presidential cycle, when there may be big shifts in policy trends. During this administration, we’ve had deregulation and tax cuts. If those trends reverse, it could weigh on future growth.

There’s also monetary policy. The Fed has played a big role in keeping this expansion going. But then it raised interest rates faster than the economy could handle before reversing course. If the Fed were to make another policy misstep and raise rates or, alternatively, if it fails to get inflation near or above its 2% target, that could increase the chance of a recession.

On the other hand, consumers account for 70% of the economy, and with a strong labor market, good wage growth and low mortgage rates, consumers are in a very good place. This is a key pillar of growth for the U.S. economy. Home prices have risen, and in the third quarter of 2019, we had the first contribution to GDP from residential real estate investment since 2017. With homebuilder confidence fairly high, I think we can expect a positive contribution from housing in 2020.

One concern would be if consumers became overly exuberant and excessively inflate asset prices or begin taking on too much debt. But in the aggregate balance sheet and financial obligations data, the U.S. consumer is still very healthy—and that’s a good indicator that growth can continue.