December 2019 - Sumner Wealth Management

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- December 2019 -

 
 

Dear Visitor,

Outlook 2020: How Real Is the Risk of Recession?

 

As we close out the year, the economy looks to be at a tipping point. Although consumer confidence remains high and job growth has been better than expected, economic trends continue to deteriorate. And unlike the start of 2019—when the trends were favorable despite the worries—the path ahead for 2020 looks less clear.

The course of 2020 depends on how these trends evolve. To be sure, the risk of recession is real. But it’s important to keep in mind that we have been in this situation before during the recovery, only to see the economy pick up again. That scenario remains the base case, for a few reasons.

First, there are signs that the economic news may be improving. Second, despite the economic risks, the political risks are starting to subside. The impeachment inquiry is likely to be resolved in early 2020, as will Brexit and very probably the U.S.-China trade war. If so, the perceived risks would be reduced materially, which will help both the economy and markets. On the policy front, the Federal Reserve (Fed) has been reducing rates, which should create a tailwind that will grow throughout the year. On balance, there is a real possibility that the policy environment will transform from a headwind in 2019 into a tailwind in 2020.

Given these factors, the base case is for continued slow growth through 2020. Corporate revenue and earnings should continue to increase, probably by more than most analysts expect. If growth trends meet expectations and confidence levels remain steady or improve, financial markets are likely to be stable and may appreciate a bit.

Slow Growth Expectations

The economy looks a bit slower than it did at the start of 2019. Consumers are still spending, but businesses are investing less. Government spending growth should continue but not accelerate. Trade is not likely to be an additive force and might well end up as a drag. These factors should leave growth slightly slower overall for 2020, at around 1.25 percent to 1.75 percent.

Monetary Policy

The real monetary policy story of 2020 is likely to be that there is no story. With slower economic growth and with inflation around 1.5 percent to 2 percent, the Fed is likely to cut rates further. This move would leave the federal funds rate in a range from 1.25 percent to 1.5 percent by year-end 2020. In turn, the 10-year U.S. Treasury yield would be around 1.75 percent to 2.25 percent. Of course, should a recession occur, the Fed would take a more active stance.

Revenue and Earnings Growth

A growing economy and a supportive monetary policy should support global stock markets, leaving them to trade on fundamentals. Revenue growth remains healthy, which is consistent with continued strength in consumer spending. Strong revenue growth should also support growth in earnings, with the rest of 2019 expected to show faster growth.

The remaining question concerns valuations. Through most of 2019, high levels of consumer confidence drove market valuations higher. If current prices hold, we should finish the year at the upper end of the range typical of the past five years or so. But as confidence levels moderate and growth slows throughout 2020, we can expect valuations to drop down closer to the lower end of that range.

As a result, the S&P 500 is likely to end 2020 between 2,900 and 3,200. There is upside potential if valuations remain at the high levels seen recently. But downside risk exists, as valuations remain quite high historically.

What Would a Recession Look Like?

The predictions above assume that the base case of continued growth and steady markets will hold. But if we do get a recession, what would it look like?

To start, it’s very unlikely to be as bad as 2008. Even in a recession, high employment levels and wages should keep consumer spending (at two-thirds of the economy) healthy. Business spending is already flat. Further, government spending growth should act as a cushion. In other words, a recession will probably be more of a deep slowdown than a collapse. This scenario is what we saw in the recessions of 1990 and 2000, and current conditions resemble those years more than 2008. The closest comparison, the 2000 recession, was not fun—but it was not like the crisis of 2008.

From a market perspective, we can draw the same conclusion. With interest rates low, stock market valuations have moved higher over the past several years. If S&P 500 valuations dropped to their lowest recent level, the index would decline about 18 percent—much less than the drops we saw in 2000 or 2008. Plus, a decline like this would be consistent with other S&P declines over the past couple of years. So, even if earnings decrease or if valuations drop further, we could conclude that the market impact of a recession would likely not be nearly as bad as in 2008.

Not a Bad Place to Be

The past year was an eventful one, particularly in terms of the political risks. Still, the economy and financial markets continued to grow, as the underlying fundamentals remained sound. Yes, the fundamentals are weakening. But the most likely outcome is continued slow growth. Even if growth becomes muted (both here and abroad) or any other issues (known or unknown) emerge, the underlying strength of consumer spending should limit any damage. And even if we do get a recession? The impact is likely to be much milder than many of us fear.

Overall, 2020 looks likely to begin with more of what we’ve seen so far in this expansion—just slower. Slower economic growth and slower market appreciation. Despite the rising risks, which have the power to change things quickly, we’re not in a bad place.

CUMULATIVE TOTAL RETURNS YTD

Equities1

Close

Week

YTD

1-Year

S&P 500

3,240

0.60%

31.8%

32.8%

DJIA

28,645

0.67%

25.8%

26.8%

NASDAQ

9,007

0.92%

37.2%

38.4%

Foreign Stocks

 

0.77%

23.0%

25.4%

Emerging Markets

 

1.21%

19.3%

21.0%

 

       

Top Three S&P 500 Equity Sectors1

YTD

Information Technology

50.6%

Communication Services

33.8%

Financials

32.2%

 

       

Bottom Three S&P 500 Equity Sectors1

YTD

Energy

11.4%

Health Care

21.2%

Materials

24.1%

 

       

Bonds2

Week

YTD

1-Year

Yield

10-Yr. Treasury3

0.35%

8.6%

9.3%

1.88%

US Bonds

0.30%

8.9%

9.2%

2.30%

Global Bonds

0.42%

6.6%

7.1%

1.44%

Munis4

0.08%

7.5%

7.6%

1.78%

 

       

Market Indicators5

 

As of

Fed Funds Target

1.75%

12/27/2019

Inflation (Core CPI)

2.30%

10/31/2019

Unemployment

3.50%

10/31/2019

GDP

2.10%

6/30/2019

1.Source: FactSet. S&P 500 is represented by the S&P 500 Index, DJIA is represented by the Dow Jones Industrial Average, NASDAQ is represented by the NASDAQ Composite Index, Foreign Stocks are represented by the MSCI EAFE Index and Emerging Markets are represented by the MSCI Emerging Markets Index.

2.Source: FactSet. Sectors based on S&P 500 Index sector indexes.

3.Sources: FactSet. 10-Yr Treasury is represented by the FTSE 10-Year Treasury Bond Index, US Bonds are represented by the Bloomberg Barclays US Aggregate Index, Global Bonds are represented by the Bloomberg Barclays Global Aggregate Index and Munis are represented by Bloomberg Barclays Municipal Bond Index.

4.10-Year Treasury yield is calculated using the Federal Reserve H.15 Report.

5.Munis yield is calculated using yield-to-worst.

6.Sources: Fed Funds Rate, Federal Reserve; Inflation and Unemployment, US Department of Labor; and GDP, US Bureau of Economic Analysis.

 

About Sumner Wealth Management

Our firm assist individuals, families, and businesses in proactively preparing themselves for a broad range of financial decisions and life events by helping our clients gain income protection, financial stability, with a solid plan.  We are an integrated, Wealth Manager Specialists. 

Mark Sumner
Financial Advisor

Sumner Wealth Management, Inc.
PO Box 4446
Mooresville, NC  28117
Direct (704) 905-3594

Investment Management
Retirement Services
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   Sumner Wealth Management | 704.905.3594 | www.SumnerWealthManagement.com

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