THE BIG QUESTIONS FOR 2020
As we settle into the New Year, investors will be asking themselves a number of questions about the outlook for the global economy, the political landscape and the likely path of financial markets. We have chosen a few of the more pertinent questions, and offer some thoughts on what we think the answers might be.
Before we begin, an obvious caveat is that predicting recessions, currencies and the direction of share prices is extremely difficult, if not impossible. Rather than trying to do so, astute investors maintain a long-term view, focus on meeting their objectives, and take a disciplined approach to managing risk.
Is a recession likely in 2020?
No, although growth will remain sluggish.
We don’t think so. Economic activity is expected to slow in a number of major regions, including the US, China and Japan. However, growth is still positive and the traditional indicators do not point to recession.
The US yield curve was inverted (a recessionary warning signal) through the middle of this year, but this is no longer the case and the yield curve is now the steepest since 2018. The US unemployment rate has historically been another good indicator of recessionary risks, and it is at a 50-year low of 3.5%.
Here in New Zealand, we are quietly confident there will be an uptick in economic activity. Business confidence has rebounded in recent months, the Fonterra payout is forecast to be the best in six years, unemployment is low and migration remains well above long-term averages. Low interest rates will provide support, and a bit of fiscal stimulus from the Government will also help.
Will the trade tensions subside, or get worse?
Subside, for now.
The trade dispute between the US and China has continued to ebb and flow, but the recent ‘phase one’ agreement is hopefully a sign of things to come.
A full-blown trade war would be a disaster for the global economy, but we believe there are strong incentives for both sides to try for a compromise. President Trump will want to get a win during the lead up to the 2020 election in November, proving that he is indeed the master negotiator and that a raft of benefits will be forthcoming in 2021.
His Chinese counterpart, Xi Jinping, will also want to put this to bed. Dealing with Trump in his second term could be a much greater challenge, while some of the Democratic candidates have equally strong views on trade.
While a truce is likely in 2020, we remain of the view that the dispute runs deeper than trade alone. As the world’s two largest economies jostle for position on the global stage, we might be watching this rivalry play out over a much longer period.
Will Donald Trump be re-elected?
If the economy remains solid, yes.
The US election is scheduled for early November, but we don't yet know who President Trump will be up against. The frontrunners are former Vice President Joe Biden, Bernie Sanders and Elizabeth Warren, although 37-year-old South Bend Mayor, Pete Buttigieg, is also considered a chance.
Regardless of the opposition, we think Trump is likely to be re-elected. However, he needs the economy to remain strong to achieve this, given that he scores low with voters on almost everything else. If Trump can keep the US ticking over, and claim a victory against China on the trade front, he’ll get his second term.
As far as our own election goes, we expect this to be close. National could well be the most popular party, again. However, the eventual result might be determined by whether New Zealand First reaches the 5% threshold (some polls suggest they are below this level at present) or not, and what it decides to do, again.
We haven’t had a one-term government since the Labour Government of 1972-1975, and if pressed to make a prediction today, our best guess would be that New Zealand will experience another three years of the status quo.
Will the OCR go any lower?
This looks like a 50/50 call, but we’ll say no.
A few months back, it was expected to fall even further from the current all-time low of 1.00%, with some economists suggesting the Official Cash Rate (OCR) would be 0.25% by mid-2020.
Today, we’ve seen a bit of an upward shift in some of the economic indicators, both local and international. Expectations of more generous fiscal policy from the Government have also taken a bit of pressure off the Reserve Bank.
All going to plan, Adrian Orr might have the luxury of leaving the OCR unchanged at one per cent, while sitting back and watching the impact of 2019’s cuts filter through the system.
We think the OCR will either remain unchanged, or be cut just once in 2020. However, given our glass half full view of the local economy and our expectation of some election year fiscal stimulus, we’ll say no change.
Which direction will the NZ dollar go?
Down, but only slightly.
On a trade weighted basis, the NZ dollar is 9.3% above its 25-year average, while it has fallen 3.0% from its 2019 highs. It is in line with its long-term average against the US dollar, but it remains higher against the Australian dollar, British pound and euro.
Economist forecasts suggest the currency will be relatively stable during the next 12 months, rather than falling much further. Although the domestic economy has slowed and the OCR is at record lows, other central banks are making similar moves amidst comparable conditions.
We suspect it will slip a little further in 2020, on average, but by a relatively modest 1-3%. This could well be due to other currencies attracting a bit more support, rather than the NZ dollar weakening.
Longer-term, taking advantage of our above-average exchange rate still makes sense to us, and we still believe some US dollar exposure is wise. Despite some potential for the greenback to weaken, it remains a safe haven currency that should perform well if we see market turbulence emerge.
Will 2020 be a positive year for the housing market?
Yes, but don’t expect
the rampant gains of a few years back.
The housing market has come off the boil in a big way during recent years, with Auckland in particular slowing dramatically. The Auckland REINZ house price index is up just 2.7% over the last 12 months, below the five-year average of 6.5% per annum. Meanwhile, the rest of NZ has gained 8.3% in the past year.
The Reserve Bank is forecasting a gain of 3.5% in 2020 for house prices nationally, which would make for a steady year, albeit one that is much more subdued than the doubledigit gains during the boom years of 2015 and 2016.
Can global sharemarkets keep rising?
Yes, but at a slower pace.
The million dollar question, and one that none of us can answer or predict with accuracy. Still, it’s our job to take a view, and despite the plethora of risks we still believe global sharemarkets could deliver positive returns in 2020. However, these are likely to be much lower than those we have seen in recent years, and it could be a slightly bumpier ride.
The NZX 50 has rallied 28.8% so far in 2019, the best calendar year performance since it came into existence almost two decades ago. This caps off a stunning return of 103.8% during the last five years (15.3% per annum) and a 251.3% gain over the past decade (13.4% per annum). These returns are substantially higher than the long-term average of 9-10% per annum, especially when the much more subdued inflationary (and growth) backdrop is considered.
Many other markets have been equally as strong, in particular the US. The S&P 500 index (including dividends) is up 29.9% in 2019, and has risen by more than 250% over the past decade.
The table below summarises the 2020 forecasts for some of the major developed market indices, namely the S&P 500 in the US, the German DAX, and the FTSE 100 in the UK.
It is notable that expectations are for relatively subdued returns (the average annual return from the S&P 500 since 1950 is 7.6%, excluding dividends), and that a larger than average proportion of returns will come from dividends.
With the local market trading at record highs, and the share prices for many companies having been driven by multiple expansion rather than earnings growth, we might see a similar theme emerge.
Equity markets are facing a number of challenges including ailing economic activity in some of the major regions, high valuations and subdued corporate earnings growth.
Geopolitical tensions are likely to remain prevalent, which will mean volatility remains high and markets will be sensitive to newsflow.
However, inflation remains low and central banks are focused on keeping monetary conditions highly accommodative. Recessions are uncommon when policymakers are taking this approach, and severe downturns in equity markets are rare outside of recessions.
Our recommendation is to remain invested, but to position portfolios defensively and expect more volatility. Ensure you are well diversified and stick to quality businesses that are ‘best of breed’. Smaller companies and more cyclical businesses tend to be more sensitive during periods of economic weakness, so conservative investors should limit exposures to these.