Investment Outlook - Desperately seeking earnings
We depart 2019 leaving behind one of the best years for stocks since 2009 thus celebrating the 11th birthday of the bull market and what now is the longest economic expansion in the USA for 150 years!! This despite the geopolitical concerns that dominated headlines and a year of almost zero earnings growth. Abundant central bank liquidity has once again saved the day and driven equity market returns. These returns were valuation and not earnings driven.
A key debate amongst investors looking into 2020 is whether we face recession or further economic expansion. While acknowledging that growth has slowed recently, our central scenario for economies is that growth will improve marginally but not materially so in 2020 and a recession will be avoided. With little evidence of any inflationary pressures central banks will remain accommodative and we expect pressure for governments to spend more via Fiscal policy.
Our central scenario for stocks in 2020 is to expect positive but much more moderate returns than 2019, perhaps in the 5-7% range. While our theme for much of 2019 was that of markets needing geopolitical reassurance, for 2020 the theme will be that of seeking earnings growth and reassurance. We expect modest mid single digits earnings growth consistent with our economic growth outlook.
We have had a strong finish to 2019 as uncertainties surrounding US-China trade, Brexit and UK politics have subsided. Geo-politics as a market factor has not disappeared however and trade will remain an item of debate as will Brexit as it enters difficult negotiations for phase 2. For the second half of the year the US Presidential election will likely dominate as the key market factor.
Upside risks to our central scenario would likely be driven by stronger than expected economic growth or Fiscal policy actions. We are conscious of being late stage in a long bull market so increasingly considering downside risks. A negative outcome to the year could be caused for example by a contraction in market valuations (P/E ratios) or for example an increase in market volatility or a challenge to market liquidity.
That highlighted, our core expectation is one of modestly positive absolute returns.
Asset class outlook:
While central banks liquidity and underpinnings fuelled much of the valuation driven bull market of recent years, we firmly believe that while central banks won’t go away, that earnings growth is critical to any further progress in 2020. A move from liquidity to fundamentals suggests its crucial we get earnings growth and our expectations are modest as detailed earlier. Assuming a modest reacceleration in economic growth, we expect that regions such as Emerging markets or Europe can deliver higher earnings growth than the USA which has been the lead market for many years now.
Despite being at or near all time highs, equity market valuations aren’t extreme and further progress can be justified but only if we see earnings growth. Looking inside markets, we continue to highlight the extremes of valuation between the ‘have’s and have-nots’ be that by investment factor (e.g. performance of low versus high yielding stocks) or style (e.g. Growth stocks versus Value stocks) which we believe to be at unsustainable levels and perhaps have started to mean revert over recent months.
Government bonds remain fundamentally overvalued in our view at low and unprecedented negative yield levels. A lack of any meaningful inflation combined with the abundant liquidity provided by central banks has been the prime reason for such low rates.
Corporate debt is also priced at extreme low yield which itself has fuelled increased leverage in corporate balance sheets, which in turn has helped fund the massive corporate buybacks over recent years.
In summary, while it is natural that such a long positive cycle should raise questions about longevity, we do not believe that any cycle should necessarily ‘die of old age’. On the contrary, we believe that the likely mix into 2020 and beyond of moderate, but positive, economic growth combined with continuing policy support, remains a propitious environment for stocks. What we believe is likely to be different is that the driver of stock returns will come more from the traditional sources of dividend yield/growth and earnings and less so from much (or any) further expansion in the market valuation multiples.
KBI Global Investors Ltd. is regulated by the Central Bank of Ireland and subject to limited regulation by the Financial Conduct Authority in the UK. Details about the extent of our regulation by the Financial Conduct Authority are available from us on request. KBI Global Investors (North America) Ltd is a registered investment adviser with the SEC and regulated by the Central Bank of Ireland The views expressed in this document are expressions of opinion only and should not be construed as investment advice.