2020 Annual Outlook

Uncertainty on the Horizon

Late-cycle market concerns make turbulence more likely in
U.S. equities – but the underlying issues may generate opportunity elsewhere.

Despite significant bouts of volatility, equity markets have continued to march on, surpassing record highs several times in 2019. At end of the October 2019[1], U.S. equities had returned over 450% since the March 2009 Global Financial Crisis bottom. Investor optimism has been supported by three successive interest rate cuts by the U.S. Federal Reserve and, more generally, hints of a return to expansionary monetary policies by central banks across the globe, coupled with the promise of a U.S.-China trade agreement.

However, uncertainty lurks on the horizon. Recurrent tensions in U.S.-China relations, lack of clarity in the implementation of Brexit, soft economic data and geopolitical tensions in the Middle East and Hong Kong, among others, have heightened investor fears and sparked volatility in equity markets. Furthermore, a number of warning signals have begun to flare, including the inversion of the 2- and 10-year segment of the U.S. yield curve in August and expectations of lower equity market returns as we enter the latter stages of this protracted expansion.

While an inversion in the yield curve is typically associated with recession, it is key to note that historically, an inversion in the U.S. yield curve has preceded a recession by an average of 14 months and in multiple cases the period between one (the inversion of the yield curve) and the other (recession) has been closer to two years.

Time Between U.S. Yield Curve Inversion (2 years - 10 years) and Recession
Source: Bloomberg. Past performance is no guarantee of future results. Indexes are unmanaged and not available for direct investment. Index returns do not include fees or sales changes. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.  Short-term dated bond yield is represented by the 2-year yield index and long-term yield represented by the 10-year bond yield. Time to recession is calculated as the time between the final sustained inversion of the yield curve prior to the recession, and the onset of recession. 

Additionally, as shown below, it is worth noting that U.S. equity market returns have been exceptionally robust prior to a peak in equity markets.

Historically Robust Equity Returns Pre-Peak Average Total Equity Return 1945-2018 (%)
Source: FactSet, Robert Shiller, S&P 500 Index, JP Morgan Asset Management. Chart is based on return data from 11 bear markets since 1945. A bear market is defined as a decline of 20% or more in the S&P 500 Index. Monthly total return data from 1945-1970 is from the S&P Shiller Composite Index. From 1970 to present, return data is from Standard & Poor’s. Past performance is no guarantee of future results. Indexes are unmanaged and not available for direct investment. Index returns do not include fees or sales changes. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment. 

Against this backdrop, investors confront two seemingly conflicting objectives; how to maintain equity market participation (for capital growth), while limiting vulnerability to a late-cycle correction or negative market shock (for capital preservation). Repositioning portfolios away from cyclical, high-beta stocks, and diversifying into defensively oriented stocks that pay sustainable dividends is a compelling strategy. 

Defensively oriented stocks can lower overall portfolio volatility and dampen drawdowns while allowing for equity market participation. Dividends typically become a larger and more stable component of total return in low return environments and lower volatility profiles may mitigate drawdowns during periods of market turbulence. Defensive equity income strategies may help investors prepare their equity allocations for a turbulent, yet potentially profitable 2020.


1 Bloomberg

Additional Outlooks
Brandywine Global
Growth in the Slow Lane

Clarion Partners
Cautious Optimism Amid Change

ClearBridge Investments
Consumers Hold the Key

EnTrust Global
Looking Beyond the U.S.

Martin Currie
Shifting the Global Balance

RARE Infrastructure
How Infrastructure Is Evolving

Royce Investment Partners
Positive Signs for Small-Caps

Western Asset
Resilient Growth, Despite Risks

The yield curve is the graphical depiction of the relationship between the yield on bonds of the same credit quality but different maturities. 

Inverted yield curve refers to a market condition when yields for longer-maturity bonds have yields which are lower than shorter-maturity issues. 

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