Rick Rieder and Russ Brownback argue that contrary to the many year-end outlooks foreseeing either a recession or a rebound in 2020, the most likely path for the economy and markets is more moderate, which can be encapsulated in their theme of “1.8.”
In the season of proliferating 2020 outlooks, and in an age of one-word answers to complex questions, often ending in hedged language like “–ish,” we think next year will be remembered as being “1.8-ish.” What do we mean by this? It’s our colloquialism for a macro/fundamental backdrop that hugs equilibrium and is underpinned by a newly pragmatic central bank policy posture that will likely be entrenched for the foreseeable future. Specifically, U.S. real GDP growth and core inflation are both poised to stabilize near their longer-run averages of roughly 1.8%, which should dictate that U.S. 10-Year Treasury rates can hover around 1.8%, in a tight trading range, while Federal Reserve policy rates also stay locked near 1.8%.
A Benign Macro and Market Outlook, Near 1.8
Additionally, from a secular standpoint, roughly 1.8 million people will hit retirement age (65) every six months in the U.S., which is nearly double the pace from just 20 years ago. That demographic development should bring historic amounts of financial asset wealth into the retirement phase of portfolio allocation every year, with a real need for income generation. And, finally, keeping with this theme: the 1.8% annual revenue growth differential between the technology sector and the S&P 500 (ex-tech) will drive investor demand for precisely the kinds of companies delivering on $1.8 trillion-ish of share buybacks, dividends, and research and development spending (see graph).
Source: CapitalIQ, data as of June 30, 2019.
The “1.8” theme has some market relevance as well. Investment-grade credit may not tighten meaningfully, but we do not expect BBB spreads to widen towards 1.8%, the pain point of last December, even as growth moderates. Nor do we expect BB spreads to tighten back to 1.8%, the tights of this year, as the companies making up this part of the index face secular challenges amidst a moderate growth backdrop that will warrant additional risk premium.
In equities, while we think EPS growth expectations are too lofty, especially those estimates above $180 per share for the S&P 500, we do expect modest 5% to 6% earnings growth next year, and we also think the P/E ratio can push a couple turns higher than the consensus expects, to near 18X. Regions of the world that have underperformed the U.S. over the last few years are also well positioned to rebound. For example, emerging markets (EM) assets will be flattered by more accommodative global monetary policy, while the Eurostoxx could handily outperform its paltry 1.8% average annual return of the last 18 years, as the ECB joins the global easing initiative.