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7 Economic Questions, Answered by BofA Analysts

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As 2020 approaches, the U.S. is experiencing the longest period of economic expansion ever recorded, but investors are apprehensive about trade, geopolitics and low growth, both at home and overseas. Meanwhile, significant technological and demographic shifts could portend a wave of changes for the global economy.

Strategists and analysts at Bank of America’s chief investment office are optimistic about the opportunities they see ahead. They recently addressed several big questions about what 2020 could bring for the markets and the economy.

1. What are some of the biggest opportunities for the markets in 2020 — and what should investors watch out for?

Chris Hyzy, chief investment officer at Merrill and Bank of America Private Bank, says 2020 will be a foundational year for a world that is in transition. He gives four reasons.

One, current monetary policy should enable the economy and inflation to run faster than they have recently.

Two, even as U.S.-China trade negotiations grab the headlines, trade around the world is transitioning from globalized to localized, which will result in increased automation and technology use. This may bring higher initial costs, but should lead to increased productivity over the next business cycle. Two global supply chains will emerge, one dominated by the U.S., the other by China.

Three, innovation can be expected to increase across all sectors, especially when it comes to data speed and information storage, as well as the build-out and redevelopment of global infrastructure.

Four, in 2020, millennials will start entering their top earning years, when their discretionary spending shifts toward owning a home, creating a family and buying things they did not previously need. Over the next decade, this will lead to the creation of the next great equity culture, similar to that of the 1980s and 1990s.

Hyzy posits three potential scenarios for the markets in 2020:

  • A “melt-up” scenario, which could significantly benefit riskier assets, like equities
  • A balanced view that mixes growth optimism with election uncertainty over the summer
  • A negative performance scenario where growth falters and geopolitical risks rise

“Our base case is the balanced view,” he says.

2. 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? 

U.S. stocks can continue to advance, but expect the path forward to be choppy and the nature of the gains to be different, says Niladri Mukherjee, head of portfolio strategy in the chief investment office.

In 2019, earnings growth was essentially flat, so the strong market was due mainly to a big expansion in price-to-earnings ratios. Next year will bring 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.

The Federal Reserve’s accommodative monetary policy was a major reason for last year’s advance, and should continue to serve as a tailwind for U.S. stocks. But two big unknowns could lead to volatility: how the U.S.-China trade relationship will play out, and uncertainty around the November U.S. presidential election.

Mukherjee and her colleagues remain optimistic about U.S. equities over international — albeit with increasing interest in international — and have a bias toward high quality and large-cap equities.

Although U.S. sectors currently offer little that is cheap, financial services stocks are trading at reasonable valuations and should be helped by a steepening yield curve and productivity enhancements. With consumer spending looking robust, consumer discretionary stocks should also do well. Select industrials, too, are also worth considering as the global manufacturing cycle stabilizes and improves.

3. 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? 

It’s still early, and markets haven’t yet focused on November elections, according to Marci McGregor, senior investment strategist in the chief investment office. Typically, from August through November in an election year, both market volatility and policy uncertainty begin to rise; indeed, uncertainty is already elevated this time around with some big ideas on the table.

As the election draws nearer, financial markets show they really care about several things, including candidates’ positions on tax and trade policies and regulation. Historically, stocks have produced average returns around 11% in presidential election years, and the market has risen almost nine out of 10 times.

McGregor says it’s important for most investors whose time horizon isn’t the end of 2020 to look longer term at the market. Markets care most about growth; they care about what consumers are doing and about corporate earnings. Fundamentals are going to drive the market in the coming year. The rest is mostly noise.

4. What are the biggest geopolitical hotspots in 2020? 

Uncertainty around the U.S.-China trade relationship is a big one, says Joseph Quinlan, head of chief investment office market strategy. As is the technology cold war emerging between the U.S. and China around which systems will be used and whether countries will be forced to choose one over the other.

Brexit is still on people’s minds, with uncertainty extended by additional factors such as the British government’s inability to reach a deal with the European Union in 2019. Still, much of that has already been priced into financial assets. Also, there is always the risk of unexpected events in places like the Middle East.

But the greatest geopolitical risk for U.S. investors, according to Quinlan, is the November presidential election. It’s important, he and his colleagues believe, to stay focused on the issues that matter to growth: policy, fiscal expansion, monetary easing, earnings growth and secular long-term themes, including demographic trends like global aging and longevity.

He suggests that geopolitical risks could even create opportunities for investors who can tune out noise and keep their nerves steady.

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

Given China’s significant weighting within emerging markets, the trade conflict with the U.S. will be the key risk factor, says Ehiwario Efeyini, senior market strategy analyst in the chief investment office. He notes that the frictions are not only 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.

In the meantime, some exporters in industries such as consumer electronics and textiles are moving production away from China into other parts of Asia, which may benefit other emerging markets, including Indonesia, Thailand, Malaysia and Vietnam.

Elsewhere, Efeyini says, economic and political turmoil in the Middle East poses risks to individual countries, but should not have a big effect in aggregate as the region accounts for just a small share of the emerging market index. Unrest has boiled over in Latin America as well, but crucially not in Brazil and Mexico, which together account for some 90% of regional market cap.

The Brookings Institution projects that another 2 billion middle-class consumers will be added to the emerging world over the next decade, which could mean that sectors will matter more than geography when it comes to future returns. Areas such as consumer discretionary, health care and technology are tied to the long-term rise of the emerging market consumer class, and Efeyini doesn’t see this trend changing, even with the trade concerns.

In addition, he says, emerging market valuations look relatively cheap compared to past levels, which suggests outperformance over the longer term.

6. 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 in the chief investment office, points out that the Federal Reserve has said repeatedly that its goal is to continue the long economic expansion, and that was its motivation for beginning to cut rates in July. The economy appears to be responding. The rate-sensitive housing and autos sectors are beginning to rebound. The Fed has signaled that, absent a significant increase in inflation, it is unlikely to raise rates. Any change in short-term policy rates will likely be a reduction, Diczok says.

He and his colleagues think investors should worry less about what the Fed may do meeting by meeting, and remember that its current goal is to keep the economic expansion going, which is generally helpful for the stock market and for investor portfolios overall.

That said, he acknowledges that the lower rate environment continues to be very hard on savers and on anyone looking for income, a situation that is unlikely to change significantly in 2020.

The team recommends 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 ones will increase more in price if yields decline. Diczok says that even at what seem like low yields, it makes sense to put money to work sooner rather than later and let compounding do the work.

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

Going into 2020, Jonathan Kozy, senior macro strategist in the chief investment office, and his colleagues expect growth to slow to around 1.7% on an annual basis — below 2019 growth, and slower than the 2.3% average during this 10-plus year expansion.

Uncertainty from the trade war and U.S. elections in November will continue to weigh on business investment and certain other parts of the economy, Kozy says. Still, recessions are common in the first year of the presidential cycle, when big shifts in policy trends may take place. During the current administration, deregulation and tax cuts occurred, and a reversal of those trends could weigh on future growth.

The Fed has played a big role in keeping the current expansion going, although it raised interest rates faster than the economy could handle before reversing course. Kozy says another policy misstep by the Fed could increase the chance of a recession if, say, it were to raise rates or, alternatively, fail to get inflation near or above its 2% target.

On the other hand, consumers account for 70% of the economy and are currently in a good place, thanks to a strong labor market, good wage growth and low mortgage rates. This is a key pillar of growth for the U.S. economy, Kozy notes. He points out that home prices have risen, and in the third quarter, residential real estate investment made its first contribution to GDP since 2017. With homebuilder confidence fairly high, a positive contribution from housing in 2020 is likely.

Kozy says it would be concerning if consumers became overly exuberant and excessively inflated asset prices or began to take on too much debt. However, the aggregate balance sheet and financial obligations data indicate that the U.S. consumer is still very healthy — a good indicator that growth can continue.


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