LIZ ANN SONDERS: As we typically do with our outlook reports, we start with an overview on the economic environment as we see it in the subsequent years and then we tie what are essentially those macro-views into what we expect for the stock market. So, let me start with a perspective on the U.S economy, which in 2019 had fairly steady growth. Nothing to write home about, but quite frankly that’s been the name of the game for this entire economic expansion. And we generally expect something similar in 2020. Probably no significant lift in growth, but so far, the conditions don’t appear to be ripe to suggest that a recession is at risk.
Now, what we had been writing about quite a bit in 2019, and we think carries into 2020, is that we do have a bit of a bifurcated economy in the United States, where we’ve had a very beleaguered manufacturing sector, much stronger services sector. Another way to divide the economy when you think about this notion of bifurcation is to look at the difference between business investment and consumer spending. Regardless of how you slice and dice it, the weakness has clearly been concentrated in manufacturing, in things like CEO confidence and CFO confidence, weak capital spending, overall weak business investment.
Now, although those represent smaller portions of the economy than either services or consumer spending, as we’ve been pointing out, they tend to punch above their weight in terms of the broader impact into the overall economy. And much like was the case in 2019, what we’re watching in 2020 is to see whether, number one, the weakness persists in manufacturing, in business investment, and whether it starts to morph into weakness in the broader parts of the economy. So far, that has not been the case. We’ve been talking about this very healthy dividing line between those portions of the economy, but also what we’re paying close attention to is the labor market because it’s typically within the labor market that we start to see that weakness more from the manufacturing or business investment side of the economy into the broader economy. So that’s one of the things that we’re watching for.
We also focus a lot on leading economic indicators. Those sub-indicators that give you a heads up on what is going to happen. Those have been kind of a flat trend over the last year or so. On a change-basis, we are down to about flat levels. That’s not a recession warning, but something we need to keep an eye on. What’s been keeping the leading indicators from moving more into negative territory, of course, has been the strength in the stock market, the un-inversion of the yield curve, still very low unemployment claims. But we are seeing some weakness in some of the other sub-indicators. So, I will keep a close eye on those leading indicators.
In terms of the implications that all of this has had and will continue to have for the stock market, clearly, we have been in a very strong stock market environment. I think that has been on the basis of all the liquidity that’s been added into the system via the Federal Reserve, lowered interest rates three times in 2019, caused a loosening of financial conditions. That’s one of the reasons why in 2019, although we had de minimis earnings growth, almost no earnings growth, we actually saw P/E ratio valuations expand. And that was because the macro-environment really supported that valuation expansion.
As we look ahead into 2020, I think we are at a stage where we’re less likely to get that boost to valuations from the macro-conditions of easy Federal Reserve policy, given that the Fed is on hold at this point; which means we’re probably at or near a stage where the “E” in the P/E, earnings, are going to have to start to do some of the market’s heavy lifting. Now, expectations are for earnings growth to pick up in 2020, back into double-digit territory in the second half of 2020. Those estimates may still be a little bit too high, unless we get a lift in the global and U.S. economy sufficient to bring those earnings estimates up. But that I do think represents a risk in 2020, that if we don’t get the expected earnings growth, that we’re not going to see much valuation expansion, if at all.
And the other risk I think we need to monitor in 2020 is investor sentiment. Courtesy of how well the stock market has done, and not just the U.S. stock market, global stock markets, really asset classes across the board over the past year is that investor sentiment has moved into the “extreme optimism” zone. Whether you’re looking at attitudinal measures of sentiment, or behavioral measures of sentiment. Now, in and of itself, that doesn’t suggest risk for the market. The market can continue to do well, investors can remain optimistic, but it does set up the possibility that if there is some sort of negative catalyst, that the weakness might be a bit more pronounced given that excess optimism. Because it might trigger some selling by investors. So, that is another thing that we’re keeping an eye on in 2020.