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거시경제 및 지정학

Three Reasons to Invest in Risk Assets… & Five Risks

2019년10월25일 - 3 분 읽기

Markets still have room, but the clouds are gathering. Last year’s scars remain fresh for many investors as they navigate toward the end of the year.

With choppy economic data and wild political headlines, how can 2020 possibly deliver positive returns? The market collapse last December even has the worriers wondering how the current 20% year-to-date gain for the S&P 500 might melt away in the weeks ahead.

In fact, the outlook for next month—and next year—remains good thanks to consumers, central banks and valuations. There is a longer list of risks looming in the distance, however, that bears close attention.

Consider the promising news first:
 

Stalwart American Consumers

The continued strength of U.S. household demand remains nothing short of remarkable. Unemployment is at 50-year lows, wages are still growing and retail sales continue to post strong results, in spite of noise in the most recent data⁠—Unemployment at 3.5%, average hourly earnings growing 2.9% year over year and retail sales growing 4.1% over the same period. Unlike the last crisis, this demand seems much more durable, since savings are high (near 8.1%) and debt service as a percentage of household income looks eminently affordable, near 9% and down from 13% before the crisis. Most intriguing, perhaps, is that with all the political and economic uncertainty that has dampened business sentiment, American consumer confidence is holding strong.

RETAIL SALES GROWTH IN MAJOR ECONOMIES

Source: Bloomberg as of September 30, 2019
 

Synchronized Central Banks

With growth slowing almost everywhere, the world’s most important central banks are on the case. Given there are few signs of price inflation, the U.S. Federal Reserve, the European Central Bank and the Bank of Japan are all trying to boost activity with cheaper money. The People’s Bank of China is easing, too, although more carefully to avoid fueling fresh property bubbles. Big questions remain, of course, about just how effective these tools will be with rates so low and $13 trillion debt trading at negative yields.1 Still, if push comes to shove, they can always return to quantitative easing.

CENTRAL BANK BALANCE SHEETS

Source: Bloomberg as of October 18, 2019
 

Reasonable Valuations

Like beauty, value remains in the eye of the beholder, but equity metrics look reasonable by historical standards and current bond yields. The S&P is trading at roughly 20 times earnings2, and the current reporting season has yet to deliver any unpleasant surprises to muted expectations, which so far has been in line or slightly better than expectations. Analyst estimates for earnings growth next year are far from heroic at 12.2% for the US and 1.4% for Europe.3

EQUITY MARKET FORWARD PRICE-TO-EARNINGS RATIO

Source: Bloomberg as of September 30, 2019

But beyond these three pillars, there’s a slightly longer list of questions around market risks.
 

What will drive new growth?

The IMF’s downgraded forecasts still have the global economy rebounding from 3% this year to 3.4% in 2020, even as trade friction leads to slower activity in the U.S. and China. But can global activity really accelerate on the back of better demand in Latin America and the Middle East? Will Europe really bounce back enough on external demand?
 

How will profits expand?

This late in the U.S. cycle, revenues and margins are bound to come under pressure even if borrowing rates remain in check. Operating margins for U.S. firms have been falling, with the Q3 margins compressing by 0.6 percentage points compared to a year ago.4 For some firms, even stodgy miners and mammoth banks, incorporating new business practices that take advantage of cloud data storage, mobile telecommunications and machine learning will deliver rich returns. But there will be plenty of losers, too.
 

Will debts be paid?

Overall debt since the financial crisis has largely shifted from private sector banks to the governments that bailed them out, but the market still worries about corporate debt that has been edging higher. U.S. nonfinancial corporate firms have accumulated debt levels 74% of GDP. In Europe, that number stands at 105% of GDP.5 Chinese corporate debt remains high, although these are mostly at state owned-enterprises where the government can keep them afloat indefinitely.
 

Can we really count on fiscal policy?

With U.S. budget deficits projected above 5% of GDP for the next several years, new federal spending that boosts growth remains hard to imagine. Even a “President Bernie Sanders” will have to offset the cost of his new social programs with large tax increases. The debate in Germany has been tiptoeing toward more spending on infrastructure or climate mitigation, but longtime Berlin-watchers are not holding their breath. China might spend more, but that will mostly help China itself.
 

Will business investment return?

Perhaps the most distressing data this year has been the decline in U.S. fixed investment as businesses delay big spending plans amid political and economic uncertainty. At some point, the decisions will have to be made even if the risks of fresh tariffs remain, but that doesn’t seem likely in the next year or two. Recent excitement over a “phase one” trade deal with China doesn’t seem likely to survive Democratic criticism heading into the Iowa caucus.

Don’t lose sight of the major forces that should keep markets strong for now, but keep a sharp eye on the many risks that may emerge. Just because we avoided them last year doesn’t mean we will always be so lucky. 

1. Bloomberg Barclays Index as of October 25, 2019
2. Bloomberg as of October 25, 2019
3. Bloomberg Q4 2020 Estimate as of October 25, 2019
4. MSCI, Bloomberg as of October 25, 2019
5. Institute of International Finance as of March 31, 2019

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