December 19, 2019
After a year dominated by U.S.- China trade tensions, fears of a hard Brexit and a global slowdown, 2019 comes to a close on a high note, with the S&P 500 hitting a fresh record high as concerns surrounding these geopolitical tail risks have eased. Looking ahead to 2020, global growth is still slowing, but the case for a rebound is building and the synchronized easing by 23 central banks has taken place since mid-2019 supports a recovery in global activity in the first half of 2020. Here, J.P. Morgan Research offers its key market and economy calls for 2020.
2019 was characterized as a tug-of-war between political conflict and macroeconomic policy. Geopolitical tensions weighed on business sentiment and prompted support from policymakers, led by significant monetary and fiscal easing in the U.S. and China. Growth is expected to slow further in the final three months of 2019, but is set to recover to above-trend levels in 2020.
“We expect further growth weakness in the fourth quarter but a recovery to above-trend global growth in 2020. The traditional imbalances that increase vulnerabilities as expansions mature remain absent,” said Bruce Kasman, Global Head of Economic Research at J.P. Morgan.
Growth in 2020 will start at a subpar pace, before picking up some time before mid-year. Political drags will likely fade and business sentiment should firm as the U.S. and China agree to a Phase 1 trade deal and there is more clarity on the likely Brexit deal.
GDP Growth in 2020
Source: J.P. Morgan Research estimates
J.P. Morgan Research forecasts 2020 global GDP growth at 2.5%, with U.S. growth slowing to 1.7% from 2.3% in 2019, as fiscal policy support rolls off and the Federal Reserve (Fed) remains dovish. EM growth should improve at the margin to 4.2%. China and the economies closely tied to its supply chain should be early participants in this lift in policy support, but most of the lift in growth is expected to come from the fading of drags in key EM countries —Brazil, Mexico, Turkey and India—as well as Europe, where weakness is expected to be transitory given still-solid fundamentals.
“The consumer remains well-positioned to keep spending and will remain the backbone of demand growth in 2020,” said Michael Feroli,J.P. Morgan Chief U.S. Economist.
As the recovery in the business cycle picks up and is expected to gain traction by early 2020, J.P. Morgan Research is setting its S&P 500 2020 price target at 3,400, based on an earnings per share (EPS) forecast of $180 with a multiple of around 19 times earnings.
Globally, the positive drivers for equity markets will likely continue, at least for the first half of 2020, as positioning is still light and equity inflows will likely make a comeback. Regionally, while U.S. equities will likely keep moving up in absolute terms, J.P. Morgan Research does not expect the outperformance that characterized the past two years to continue. Despite the reduced risk of a disorderly Brexit and consistent underperformance, the FTSE100 is not the best way to position for a more supportive U.K. political backdrop.
“EM equities stand to benefit most from a turn in global manufacturing, a Phase 1 trade truce, and from some likely pick-up in China data flow,” said Mislav Matejka, Global Equity Strategist at J.P. Morgan.
A number of markets appear expensive as 2020 approaches, but investor overweight positions are not yet concerning.
“It is unusual for markets to be expensive around a turn in the business cycle and this points to less upside going forward and more vulnerability to shocks. But investors are not highly overweight yet and not all markets expensive, particularly non-U.S. equity markets and some EM bonds and foreign exchange markets,” said John Normand, Head of Cross-Asset Fundamental Strategy at J.P. Morgan. To position for reflation, investors would typically short or expect the price of developed market (DM) bonds to fall, be overweight equities versus bonds, overweight commodities and short the U.S. dollar (USD). However, typical reflation periods also include central bank hikes, which are not expected in 2020.
For 2020, EM duration is attractive because central banks are easing, as are cheaper, under-owned non-U.S. equities in the short-term.
For currencies and commodities, oil will likely outperform over the next few quarters based on the increase in OPEC+ supply cuts. Base metals are expected to move higher over the next few months due to positioning, but not as much as in past reflation moves.
In 2020, J.P. Morgan Research expects to see a rotation by retail investors away from bond funds and into equity funds. 2019 was a very unusual year in terms of the behavior of retail investors, with close to record-high bond fund buying and record-high equity fund selling. In 2019, bond fund demand from retail investors reached a record high of $850 billion, while retail investors sold equity funds at the strongest pace since 2008, with outflows reaching around $360 billion according to J.P. Morgan Research estimates. Signs of an improvement in the global industry cycle into 2020 support a reversal of this year’s equity fund selling and a big downshift in bond fund buying.
“We look for 2020 to be the year of the Great Rotation II, in a repeat of 2013 — we expect a rotation by retail investors away from bond funds and into equity funds,” said Nikolaos Panigirtzoglou, Global Markets Strategist at J.P. Morgan.
The combination of an $840 billion deterioration in bond demand and a $375 billion decrease in bond supply leaves us with a net deterioration in the bond supply/demand balance of around $460 billion in 2020, reversing this year’s $400 billion improvement.
The $375 billion reduction in global bond supply estimated for 2020 reflects both a decline in net government supply in the U.S., as the Fed is no longer contracting its balance sheet and lower net corporate bond issuance falls globally.
J.P. Morgan Research expects broad but modest U.S. dollar (USD) weakness in early 2020 – but this is not likely to last for multiple quarters. Instead, a weakening of the U.S. economy from an emerging fiscal drag, among other factors and a dovish Fed, should only narrowly weaken the dollar versus other reserve and low-yielding, current-account surplus currencies.
“We see broad but modest USD losses early in 2020 on global lift, but doubt whether this extends to a secular bear market as this would require a V-shaped recovery,” said Luis Oganes, Head of Currencies, Commodities and Emerging Markets Research at J.P. Morgan.
At the same time, cyclically sensitive, higher-yielding currencies in G10 and EM will likely struggle to extend any early lift against the dollar. Importantly, with the partial rollback of the September 1 tariff to 7.5% from 15% as part of the U.S.-China trade truce, the USD to Chinese Yuan (CNY) exchange rate should be well supported, at least in the first half of the year. This should also benefit EM currencies particularly those that are closely tied to the China supply chain.
Oil prices will likely be boosted by the higher cuts in supply committed to by the Organization of the Petroleum Exporting Countries and its allies (OPEC+) and the envisaged rebound in global growth, particularly in EM. J.P. Morgan Research expects the oil price to peak in the first three months of 2020 at $67 per barrel before dampening as increased supply from non-OPEC producers hits the market.
Brent should average $64.5 per barrel in 2020. However, there balanced risks to this outlook: on the upside, if the global recovery is synchronized, the boost to EM growth could be higher than envisaged raising demand. On the downside, we are assuming full compliance to quotas from OPEC in the first half of the year but expect marginally weaker compliance in the second half, owing to seasonal demand for OPEC crude and uncertainties over an extension of current quotas beyond June 2020.
EM central banks have been cutting policy rates since the second quarter of 2019 and are expected to ease policy further in the first half of 2020, as growth remains subpar. EM inflation is also expected to remain benign, despite a modest pickup in core inflation, due to localized food price increases, particularly in China. While some EM central banks (such as India) have paused against the run of play, many have continued to ease more than expected even in the final few months of 2019.
“Although the Fed has signaled a pause in its easing cycle, EM central banks have continued to cut policy rates in the final quarter of 2019 and are expected to continue doing so during the first half of 2020, as growth remains subpar and inflation pressures remain modest,” added Oganes.
U.S. Treasury yields are set to retrace to higher levels seen in the second half of 2020, as U.S. and global growth returns above trend. J.P. Morgan Research is targeting 2-year and 10-year yields to end 2020 at 1.6% and 2.05%, respectively. Investor positioning and global sovereign rates are set to remain major drivers of Treasury yields, with over $13 trillion in negative yielding sovereign debt contributing to rich assets and a desperation for yield.
“2020 should be a weaker year for returns on duration and a better year for spreads. Investable Treasury supply will contract. Ample cash and constructive policy interventions point to tighter funding spreads,” said Alex Roever, Head of U.S. Rates and Short Duration Research at J.P. Morgan.
Year-end funding issues have been a major focus for market participants since mid-September and arguably since the end of last year. Watch out for a spike in rates on the last trading day of the year, but there should be sufficient liquidity in the marketplace, as ample cash and constructive policy interventions point to tighter funding spreads. In total, the Fed has now committed to providing $640 billion in liquidity over year-end.
GDP Growth in 2020
Credit spreads, or the difference in yield between U.S. Treasuries and other debt securities are tightening across the global credit complex. Lower risk, investment grade corporate bond spreads are expected to tighten by around 15 basis points, as net issuance falls roughly 30%.
“We forecast moderate spread tightening across the global credit complex. Depending on market segment, we are forecasting that spreads will tighten 5-10% and have slightly higher confidence levels in high grade than we do high yield, in turn reflected in modest decompression between the two. This said, we do expect some further compression between EM corporates and sovereigns in the coming year,” Stephen Dulake, Global Head of Credit Research at J.P. Morgan Research.
Fallen Angel risk, or corporate bonds that have lost their investment grade status, is mitigated by lower BBB issuance and deleveraging by some of the largest BBB issuers. J.P. Morgan Research is neither forecasting a recession nor a material rise in interest rates for 2020. For U.S. high yield, full-year returns of 7.5% are expected, EM corporates are forecast to outperform sovereigns in the coming year, though will perform broadly in line with DM corporates.
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