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Economic resilience, Fed and elections to drive US markets in 2020



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Author 1

2019 proved a strong year for US assets, with US equity markets recording the strongest annual total return since 2013 and the US aggregate bond index up almost 9.0%. In addition, the past decade proved the best ever for the S&P 500 index, which returned 256% overall, well above its historical average. It was also the decade when US equities dominated other markets, with an outperformance of more than 90% versus the MSCI World index.

Despite such highs, we believe that US assets still off er compelling opportunities for global investors in 2020, though these are dependent on the evolution of three themes:

■ The resilience of private consumption amid the expected US economic slowdown. Since private consumption accounts for about 70% of US GDP, it will be crucial to monitor this component. In our view, this will remain solid and is able to bear some labour market cooling.
Monetary policy trends, as the Federal Reserve should not deliver an extra rate cut unless economic data disappoint, especially on the labour market front. Easy financial conditions should remain supportive of risky US assets.
■ The upcoming presidential election, which will shape economic policies over the next four years, together with market trends and sector rotation throughout this year. The electoral campaign has already de facto started, in a tense climate due to the impeachment process, while democratic candidates are preparing for the primaries. ‘Centrist’ candidates (Biden, Buttigieg and Bloomberg) will oppose ‘radical/social-Democratic’ candidates (Warren, Sanders). This is the first time that radical proposals within the Democratic Party have been pushed by candidates who have a real chance of winning the primaries. A Trump re-election is far from certain and the evolution of his electoral odds could be a source of market volatility.

Our key convictions on US assets for 2020 are as follows:

US fixed income: The range of Treasury yields will be wide this year, with yields possibly trending higher in the first part of 2020 as the economy reaccelerates, but lower in the second part of the year in the event of political tensions and decelerating growth. Duration should not contribute significantly to returns. We prefer a neutral/ short duration stance to start the year and expect a steepening of the yield curve. Stabilising growth and the dovish Fed stance will support credit markets. However, investors should be cautious given the deteriorating micro fundamentals. As such, we favour high-quality carry with an increasing focus on liquidity. HY is attractive on a selective basis. Securitised assets offer carry opportunities and are attractive relative to most corporate bonds.
US equities: The bull market will continue, though soften, and the electoral outcome will affect sector rotation and drive some volatility. An acceleration in EPS growth in the first half of 2020 should sustain the rally. Share buybacks should add about 2 pp to overall EPS growth in 2020. One area that needs attention is the high market concentration: the weight of the top five companies in the S&P 500 index has reached the highest level since 1999, at about 17%. Investors could mitigate this concentration risk by increasing diversification and focusing on bottom-up selection in cyclicals/value stocks.
From a cross-asset perspective, equities are likely to offer higher return potential.

Authors 2&3


The bottoming out of leading indicators is more likely than a widening in credit spreads.








In the HY universe, the decoupling between euro and US HY spreads has been mostly an energy story.






The combination of supportive macro fundamental trends and tight valuations calls for high selectivity in credit markets.

Fixed income: attractive yields in range-bound markets

Following the three rate cuts agreed by the Fed last year, the bar for delivering further accommodation is high, and the central bank may be willing to allow some inflation overshooting (unlikely) before hiking rates. The renewed expansion of the Fed’s balance sheet will keep financial conditions loose – even if it cannot be seen as a new round of QE – and will limit the upside pressure on rates. Politics will remain centre stage, with Trump’s impeachment trial and the electoral campaign set to get under way later this year. The political attack on the Fed’s independence should continue, with pressure on the central bank to cut rates further and weaken the dollar. The 10-year US treasury yield is likely to trade in a wide range and remain dependent on macroeconomic and political risks. Overall, we foresee limited upside on US yields, with potential opportunities in a trading range and neutral duration positioning, with a focus on steepening.

In 2020 US credit markets will remain supported by benign macroeconomic trends and technical factors. On the former, the US economy is expected to grow more slowly this year but stay supportive for markets at – or slightly above – potential GDP growth. Regarding technical factors, neutral bank lending standards are supportive, together with low equity-implied volatility driving both HY and IG risk premiums. In addition, distress ratios – the share of HY bonds trading at spreads larger than 1,000 bp over government bonds – remain unthreatening.

However, micro fundamentals are not as healthy. Valuations are tight and getting even tighter due to the search for income in a low-yield environment for global fixed income, coupled with a strong increase in outstanding corporate debt over the past decade. Outstanding US IG corporate debt has increased from an estimated 2.3 trn USD in 2007 to 7.3 trn USD currently, and most of this expansion has occurred in the BBB-rated segment, which currently accounts for about 50% of the US IG market. Valuations appear too high versus leverage metrics, especially among lower-rated IG issuers. While this may not be a big deal in the short term, it is a risk for market trends in the longer run.

Over the course of 2019, spreads decoupled from macroeconomic leading indicators, failing to incorporate the higher risk premium consistent with the fall in confidence indicators. The most recent stabilisation of the Manufacturing ISM index, together with the positive news fl ow on global trade developments, bodes well for a reduction of this valuation gap. Such a reduction is likely to be driven by the bottoming out of leading indicators rather than by a widening in credit spreads.

Figure 1

Despite the dramatic rise in outstanding US IG debt, US corporates are cautious in managing their financial leverage, especially BBB-rated firms, to avoid being downgraded into the HY universe and to keep the cost of funding under control.

In the HY universe, the recent decoupling between euro and US HY spreads has proved to be mostly an energy story. If this sector is excluded, US HY trends stabilised last year, in line with trends in the European HY market, while the energy sector showed signs of distress. Of the 64 defaults recorded globally over the first nine months of 2019, 19 – or 30% of the total – were in the energy sector, according to the latest Moody’s report on defaults. The energy sector’s share of defaults was 19% over the same period of 2018. The key reason for the deterioration was the plunge in oil prices at the end of 2018, which weighed on both the default rate and the distress ratio of the sector.

Figure 2

The combination of supportive macro fundamental trends and tight valuations calls for high selectivity in credit markets. Fixed income investors should seek opportunities across multiple sectors, with a focus on diversification and liquidity. Investing in securitised credit sectors, including asset-backed securities, commercial mortgage-backed securities (ABS) and residential mortgage-backed securities (RMBS), is consistent with this approach. These sectors are attractive when considering their relative valuations, strong credit protection, US consumer focus and lower exposure to global growth risks. Agency mortgage-backed securities are attractive relative to US Treasuries after the recent spread widening.

Table 1


Author 4





Yields in the agency MBS market offer an attractive entry point versus Treasuries.






Beyond traditional credit: securitised assets in focus

Securitised assets off er search-for-yield opportunities in 2020. They are financial instruments where cash flows are derived from and secured by specific underlying collateral. In a securitisation, assets are sold into a trust, which then issues securities backed by those assets. Securitisations include bonds backed by residential mortgages, commercial mortgages, automobile loans, credit cards, bank loans made to corporations and other assets. By assigning different payment priorities to each bond within a securitisation, investors can access a menu of risk and return options in terms of both interest rate risk and credit risk. The most common securitisation is the mortgage-backed security (MBS), where residential loans serve as the collateral. Within the MBS market, the largest sector is agency MBS, with these akin to the covered bonds issued by the government-sponsored enterprises Fannie Mae, Freddie Mac and Ginnie Mae. Agency MBS differs from private-sector securitisations because they off er an explicit or implicit guarantee from the US government. In contrast, individual investors are responsible for the credit risk embedded in the higher-yielding segment of residential, commercial, consumer and other securitised credit.

Figure 3

Securitised assets were at the epicentre of the 2008 global financial crisis. Thanks to stronger consumer balance sheets and the market reforms that have taken place since then, it is unlikely that securitised assets will cause the next crisis. The backward-looking bias often embraced by investors explains the current disconnect between risk premiums and fundamental risk. Today, US household debt service costs are at their lowest levels since 1980 and the US savings rate is above its long-term average. Amid a weakened global growth environment, the US consumer has remained resilient. For this reason, fi xed income investors can benefit from investments in securitised credit sectors that are supported by the financial health of the US consumer. Yields in the agency MBS market off er an attractive entry point versus Treasuries. While agency MBS have little to no credit risk because of the explicit or implicit guarantee from the US government, the expected returns on these securities are higher than comparable duration US Treasuries due to the prepayment option of the underlying borrowers. Investors are compensated for taking this prepayment risk. With the recent decline in interest rates, investors are overpricing the risk of these prepayments, and spreads appear dislocated compared with IG corporate bonds. Refinancing rates between different agency MBS sectors have diverged due to technological and systemic enhancements in the mortgage origination industry, but careful security selection can mitigate these risks and potentially lead to excess returns. Securitisations are believed to be illiquid but agency MBS and high-quality ABS off er investors liquidity second only to US Treasuries, while higher-yielding securitised assets can exhibit lower liquidity than comparably rated corporate credit, due to their smaller issuance size and lower transaction volumes. Like any investment strategy, it is critical to price this risk and match the liquidity of the assets with the liquidity of the investment vehicle and the investment goal.

Authors 5 et 6




The Manufacturing ISM index could bottom out over the next few months, allowing the US bull market to continue throughout 2020.






EPS growth will benefit from share buybacks, which will contribute 2% to overall EPS growth in 2020







After the strong 2019 rally, equities could still move higher but selectivity will be key given high valuations in some defensive sectors.

US equity bull market should continue, but soften

The US equity market is entering 2020 in the longest bull run in history, though not the strongest. In terms of cumulative total return, the current bull market ranks second only to the expansionary cycle that started in 1990.

Figure 4

To assess if such a trend will continue this year, monitoring the developments of the Manufacturing ISM index will be crucial. We should bear in mind that in a scenario of slow consumption and inflation, low official rates and low bond yields, the Manufacturing ISM and equity markets show high correlation. The Fed delivered three rate cuts in 2019. Since monetary policy operates with lags on the real economy, the Manufacturing ISM index could bottom out over the next few months, allowing the US bull market to run throughout 2020. The favourable geopolitical landscape – should it be confirmed as in our main scenario – will provide a window of opportunity, at least until the electoral campaign for the upcoming presidential election officially gets underway.

Figure 5

At 10% YoY, the 2020 IBES forecast for US earnings growth is somewhat optimistic, in our view. Over the past 10 years, such consensus has been constantly downgraded as the year progresses and this year should be no exception. We expect US earnings growth to be mid- to high-single digit, aided by a recovery in manufacturing activity. Earnings growth will also be helped by easy comparisons in some cyclical sectors, such as energy and materials, where earnings were depressed in 2019.

Figure 6

P/E ratios are reasonable when factoring in the low interest rate environment and should support equities further early in the year. Later on, an acceleration in EPS growth should cause equities to move higher. EPS growth will benefit from share buybacks, which we estimate will contribute 2% to overall EPS growth in 2020.

Finally, investors should monitor the upcoming run-up to the 2020 presidential election. Since World War II the US equity market performance has been shaped primarily by the business cycle momentum and secondly by economic policies pursued under different presidents, as different policies may cause sector/single stock rotation.

Figure 7

Our main scenario is exposed to a few low probability risks, including:

■ Geopolitical developments could prove more fragile than anticipated and the long-term relationship between China and the United States could deteriorate;
■ Other international geopolitical risks could flare up (e.g., Turkey, Middle East tensions);
■ US domestic political developments could prove adverse and include Trump’s possible, but unlikely, removal from office and/or the emergence of a populist Democratic candidate;
■ Deteriorating US domestic economic growth, with weak manufacturing and services sector performance.


We expect no additional fiscal stimulus to be passed on top of the package delivered in 2017.




US economic growth will decelerate to 1.7% this year from its peak, hit in Q2 2018.





In 2020 US growth will be driven by domestic demand.





The labour market appears resilient, with low unemployment, strong hours worked and moderate wage growth.



US economy to stabilise, supported by resilient domestic demand

Following the 2019 slowdown, US economic growth will stabilise around potential consumption will be the main driver, while investment will prove weak. Core inflation will stay on a mild upward trend, as the positive output gap supports domestically generated inflationary pressures. Headline inflation is likely to accelerate in the first half of 2020 and moderate later, with headline CPI estimated to pick up at an average of 2.3% from 1.8% in 2019. Under such a scenario, the Fed could deliver an extra rate cut this year should data deteriorate further, but the bar for delivering further accommodation is high. Such an outlook relies on a set of assumptions:

■ On trade, we assume no further escalation in the US-China trade dispute, with an extension of the status quo. Global trade growth will rebound somewhat from the 2019 lows and then stabilise at a lower growth pace than in the past.
■ On fiscal policy, we expect the current split Congress to deliver no additional fiscal stimulus. Further stimulus is more likely in 2021 following the presidential election and conditional on its outcome.
■ On monetary policy, the Fed delivered significant easing last year and rates are now below their estimated neutral level. An extra cut could come in the case of disappointing economic data, in particular on the labour market front. The latest Fed summary of economic projections, released in December, and included growth and inflation forecasts that could prove overly optimistic.
■ On geopolitics, we do not expect any disruptive events that could raise uncertainty and have negative spillover effects on confidence this year. On the domestic front, as the Democratic candidate will be chosen by mid-year, markets may react to this nomination, especially should the candidate be perceived as market unfriendly.

2020 growth outlook

We expect the US economy to decelerate this year, with growth of 1.7% taking it towards its long-run growth potential, down from the peak hit in Q2 2018. This is due to the bulk of the positive impact from the fiscal stimulus delivered by the 2017 Tax Cuts and Jobs Act and the easier monetary policy having faded. The output gap, which closed in mid-2018, according to the Congressional Budget Office, will stay positive until mid-2021, with GDP growing above its potential and supporting core inflation to uptrend gradually (we estimate the core PCE deflator will average 1.9% in 2020, up from 1.6% last year).

Figure 8

Growth will be driven by domestic demand. Private final demand – which includes private consumption, investment and stock building – has responded strongly to lower interest rates, particularly in interest-rate sensitive segments such as housing and consumer durables. Private consumption trends will be key. While interest rates remain supportive, their impulse will have increasingly lower marginal impact. The relative strength of US household balance sheets – which have been cleaned up following the Great Financial Crisis – could be a cushion in case of deteriorating labour market conditions. Meanwhile, rising inequality in wealth distribution makes some segments of the population more vulnerable, especially lower-income households, which remain the weak link as they are particularly exposed to a possible deterioration in labour market conditions. This may limit the recovery of private consumption this year. 

Figure 9

The labour market appears resilient, with low unemployment, strong hours worked and moderate wage growth. However, a few signs of deceleration are appearing, as hires, quits and separations have plateaued at cycle highs, while job openings are declining. In addition, the duration of unemployment is increasing, flagging the risk that the jobs market could be losing momentum, albeit is still cyclically strong. As aggregate income growth slows, personal consumption growth will soften as a consequence. The overall resilient consumption pattern is counterbalanced by the weakness in manufacturing and capex, which is expected to persist into 2020. These diverging trends are highlighted by the Q4 2019 Fed Senior Loan Officer Survey, according to which demand for commercial and industrial loans has weakened notwithstanding stable lending conditions, while demand for loans to households has strengthened for most categories, even against the tightening standards in credit card loans.

Regarding fixed investments, their weakness has been related to global factors, with policy-related uncertainty weighing on US business confidence. This uncertainty has long-lasting decelerating effects on key components of non-residential investments, including structures and equipment investment. In 2020 the uncertainty will remain and will pivot from trade issues to the upcoming presidential election, preventing a meaningful improvement in non-residential investment trends, especially in the context of slowing private consumption. Moreover, as tariff -related and domestic pressures drive input prices higher, corporate margins may come under pressure, limiting capex spending capability.

On residential investment, we do expect some improvement as it benefits from lower interest rates. Finally, net trade is expected to marginally drag from growth in 2020 after having shaved 0.3% in 2019 as a whole, according to our estimates.


US GDP growth has averaged a solid 2.6% so far in Trump’s term, one of the strongest growth rates since Clinton’s 4.5% in his second term.







We expect a Democratic House and a Republican Senate out of the 2020 Congressional election.

Focus on 2020 presidential election

On 3 November the United States will hold a presidential election, an event that could impact the global economy and financial markets. While the political fundamentals favour a Democratic candidate over President Trump, the economic fundamentals help level the playing field. Ultimately, the US presidential election will either be determined by President Trump’s handling of the economy and labour market or it will become a referendum on impeachment and concerns over Trump’s moral proclivities. We see a 50% chance of the Republican Party retaining control of the White House, with four possible scenarios to unfold:

■ Trump re-elected (45% chance): The economy remains robust and Trump’s style of politics boosts the unfavourable ratings of his Democratic opponent – the classic lesser of the two evils, a repeat of the 2016 election. A weak Democratic nominee could make this task easier.
■ Another Republican nominee (5% chance): In a scenario where scandal envelops Trump, forcing him to resign, he is forced out of office or he does not run for re-election, the Republican Party will have to find a replacement nominee. The most obvious choice would be Vice President Michael Pence, but other prospective candidates should be considered as well, including Utah Senator Mitt Romney.
■ Established Democrat (30% chance) such as Joe Biden: The US economy slows and Trump’s approval rating falls below 40%; the election becomes a referendum on impeachment.
Populist Democrat (20% chance) such as Bernie Sanders or Elizabeth Warren: The economy slumps into recession, increasing fatigue about the ongoing scandals plaguing Trump, and disenchantment about income inequality feeds the narrative for a seismic shift for change.

The election outcome will evolve around a few factors:

 Economy/labour market: This is one of the few areas where Trump has polled consistently well so far. It is also the most important factor for him to be re-elected. Trump’s approval ratings for his handling of both the economy and jobs generally remain favourable. US GDP growth has averaged a solid 2.6% so far in Trump’s term, one of the strongest growth rates since Clinton’s 4.5% in his second term. If the economy keeps growing above trend and the unemployment rate remains around 4.0%, voters may vote to re-elect Trump.
 Referendum on impeachment: Following the House of Representatives’ vote to impeach President Trump on charges of abuse of power and obstructing Congress, we expect him to be acquitted in the Senate trial. The strength of the economy should help Trump win a second term, but concerns over the impeachment could overshadow the strong economic performance. Concerns on whether Trump broke the law could force voters to express their displeasure against him rather than voting for the economy. The nation remains divided, with a slight plurality of 47.8% in support of the impeachment inquiry and removal from office while 46.1% disagree, according to polls in December 2019.
Democratic opponent: Trump’s Democratic opponent will also have an impact on his re-election. We believe an establishment Democratic candidate would have a better chance of defeating Trump than a populist one. There is a divide within the Democratic Party between candidates embracing progressive policies such as ‘Medicare-for-all’ and those calling for moderate incremental changes to policies such as healthcare. The Democratic electorate will pivot between the issues that matter the most to them and electability. The latter has been the key motivating factor thus far. According to a Fox Poll taken on 15-17 September, 56% of Democratic primary voters support the candidate they feel has the best chance of beating Trump, while only 31% support the candidate they like most. It would probably take a US recession or profound social upheaval for US citizens to elect a populist Democratic candidate.

2020 Congress election

This year US citizens will also vote to renew all 435 members of the House of Representatives and 35 Senate seats. We expect the outcome to be for a Democratic House and a Republican Senate. In the House of Representatives, Republicans need to win 18 seats to regain the majority, while retaining two vacant Republican seats. The Cook Political Report currently rates 18 Democratic seats as ‘toss-ups’, while only five Republican seats are considered toss-ups. The Republican Party would need to sweep each of the Democratic toss-ups while losing none of their own – a tall order. It remains an uphill battle for the Republican Party to take over the House for two reasons:

■ The number of Republican retirements is soaring, hitting 18. Presumably, Republican representatives would not be retiring unless they viewed the prospects of regaining the majority as challenging.
■ In our analysis of the election cycles, the House majority has not flipped twice in a row since 1954.

In the Senate, the Democrats need three seats to gain a majority if they win the Presidency – the vice president breaks a tie if the Senate is 50/50 split – and four seats if they do not win the presidency. While the Republican Party has the advantage, the Democrats have a fighting chance of taking the majority if everything goes their way. Republicans have more seats to defend – 23 vs. 12 – but most of their seats are in their strongholds. We estimate there are three Republican toss-up seats, while only one Democratic seat is expected to change party. The markets may be underestimating the recent trend of partisan voting, whereby there is less ticket splitting, which happens when traditional Democratic or Republican voters vote for one party in the national election but vote for the other party in the local races. This means there is a greater likelihood that the state winner on the president’s side will most likely win the Senate race. This could indicate a tighter contest. Overall, the market impact will be favourably disposed from Trump’s campaign platform on energy and regulatory/tax policy, while negatively disposed to his fiscal, trade and dollar policy. On the other hand, the market is likely to react most bullishly to a potential GOP nominee’s stance on all the key issues, except fiscal. On the Democratic side, the market is likely to react more positively to the establishment Democratic agenda rather than the populist one (see Figure 10).



Infographic V2



 ABS: Asset-backed securities. These are financial securities such as bonds, which are collateralised by a pool of assets, possibly including loans, leases, credit card debt, royalties or receivables.
Asset purchase programme: A type of monetary policy wherein central banks purchase securities from the market to increase money supply and encourage lending and investment.
Basis points: One basis point is a unit of measure equal to one one-hundredth of one percentage point (0.01%).
Bond ratings: Source: Moody’s and S&P. If the ratings provided by Moody’s and S&P for a security differ, the higher of the two ratings is used. Bond ratings are ordered highest to lowest in portfolio. Based on S&P measures: AAA (highest possible rating) through BBB are considered investment grade; BB or lower ratings are considered non-investment grade. Cash equivalents and some bonds may not be rated.
Credit spread: Differential between the yield on a credit bond and the Treasury yield. The option-adjusted spread is a measure of the spread adjusted to take into consideration possible embedded options.
Curve steepening: A steepening yield curve may be a result of long-term interest rates rising more than short-term interest rates or short-term rates dropping more than long-term rates.
Default rate: Percentage of issuers that failed to make interest or principal payments in the prior 12 months. Default rate based on BofAML indices. Universe consists of issuers in the corresponding index 12 months prior to the date of default. Indices considered for corporate markets are ICE BofA-Merrill Lynch.
Diversification: Diversification is a strategy that mixes a variety of investments within a portfolio, in an attempt at limiting exposure to any single asset or risk.
Duration: A measure of the sensitivity of the price (the value of principal) of a fixed income investment to a change in interest rates, expressed as a number of years.
Fallen angel: A fallen angel is a bond that was given an investment-grade rating but has since been reduced to junk-bond status due to the weakening financial condition of the issuer.
 MBS, CMBS, ABS: Mortgage-backed security (MBS), commercial mortgage-backed security (CMBS), asset-backed security (ABS).
Option-Adjusted Spread (OAS): The measurement of the spread of a fixed-income security rate and the risk-free rate of return, which is adjusted to take into account an embedded option.
Purchasing Managers’ Indices (PMI): Purchasing Managers’ Indices (PMI) are economic indicators derived from monthly surveys of private sector companies. A reading above 50 indicates an improvement, while a reading below 50 indicates a decline.
Quantitative Easing (QE): QE is a monetary policy instrument used by central banks to stimulate the economy by buying financial assets from commercial banks and other financial institutions.
REIT: A real estate investment trust (REIT) is a company owning and operating real estate which generates income. Most REITs specialise in a specific real estate sector, focusing their time, energy and funding on that particular segment of the real estate horizon.
RMBS: A residential mortgage-backed security (RMBS) is a debt-based security backed by the interest paid on loans for residences. The risk is mitigated by pooling many such loans to minimise the risk of an individual default.
Rising star: A rising star company has a low credit rating, but only because it is new to the bond market and still establishing a track record. It does not yet have the track record and/or the size to earn an investment-grade rating from a credit rating agency. 
Spread: The difference between two prices or interest rates.
Toss up: 50-50 chance.
Volatility: A statistical measure of the dispersion of returns for a given security or market index. Usually, the higher the volatility, the riskier the security/market.

J. TAUBES Kenneth , CIO of US Investment Management
TODD Christine , Head of US Fixed Income
BERTONCINI Sergio , Senior Fixed Income Strategist
FUNDERBURK Noah , US portfolio manager
PIRONDINI Marco , Head of Equities, US Portfolio Manager
MIJOT Eric , Head of DM Strategy Research
USARDI Annalisa , Senior Economist
UPADHYAYA Paresh , Director of Currency Strategy, US Portfolio Manager, US
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Economic resilience, Fed and elections to drive US markets in 2020
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