Key Risks in 2020
What are the biggest risks facing the economy in 2020 and how should you manage them?
Key risks as we head into 2020
With the end of the year approaching and everyone (including us) set to go on a holiday hiatus, we thought it would be fun and instructive to highlight some key risks heading into 2020 and the upside and downside cases associated with each risk. Though not an exhaustive list, we present some important topics to think about as we close out 2019.
Current Status: The U.S. and China recently concluded “phase one” of their negotiations. The agreement avoided additional tariffs on December 15, but left tariffs on roughly two-thirds of Chinese imports intact.
Upside Case: The U.S. and China make progress in subsequent “phases” which could roll back existing tariffs. No further trade barriers get erected. Business sentiment improves.
Downside Case: More challenging discussions between the U.S. and China break down. The administration erects trade barriers on partners in Europe and Latin America. The administration’s blocking of new appointments to the WTO’s appellate body threatens to paralyze the organization, resulting in increased tensions between trading partners.
Our Take: We do not view the “phase one” agreement as substantial and therefore should not remove uncertainty nor improve business sentiment much. Subsequent phases should prove more contentious. Trade policy should remain a headwind for economic growth in 2020.
Current Status: Valuations across asset classes remain at or near record-high levels. Only the level from the dot-com bubble exceeds the current level for the cyclically adjusted price-to-earnings ratio for U.S. equities. Bond prices remain elevated after three rate cuts of 25 basis points (bps) each in 2019. Cap rates across property types still hover near historically low levels. Residential real estate prices reach record levels.
Upside Case: Asset prices do not overinflate, nor do they collapse. Asset markets provide steady returns to investors and help to bolster the wealth effect of consumption.
Downside Case: A large price movement up or down could prove disruptive. If prices increase too much, fears of another bubble could inflate. If prices decrease too much, investors and consumers could fret and pull back on spending, worsening the economy.
Our Take: We do not foresee large movements in asset prices up or down that should cause systematic concern. Volatility could increase, but an inflection point seems unlikely in 2020. Valuations should remain elevated, but not at the level that should be viewed as a bubble.
The Labor Market
Current Status: Labor market continues its strong performance with a marked labor shortage, characterized by a half-century low unemployment rate, year-over-year wage growth in excess of 3%, net job gains averaging roughly 180,000 through November, and open but unfilled positions still tallying more than 7 million.
Upside Case: The labor market continues to generate net employment gains, even as growth slows. Wage gains slowly accelerate as the labor market tightens further. The unemployment rate trends flat to down further.
Downside Case: Negative business sentiment spills beyond investment into hiring and job growth slows more than anticipated or job cuts emerge. Slower employment growth begets slower GDP growth or job losses result in GDP contraction.
Our Take: The labor market is slowing but should remain tight. Wage growth should remain healthy and the labor shortage should remain intact. We foresee consumers’ contributions to GDP growth slowing in 2020 as job growth slows.
Current Status: The target Fed funds rate sits in a range of 150-175 bps. The Fed does not expect further cuts or any increases in 2020. The Fed quietly reflated its balance sheet by more than $300 billion after disruption in the repo market in the fall. This reversed roughly half of the reduction that occurred over the last few years.
Upside Case: The Fed ‘s decisions support private investment, both residential and non-residential and the economy does not require substantial changes to rate policy. The expansion of the balance sheet does not encourage excessive risk-taking.
Downside Case: The rate cuts from 2019 prove ineffective at alleviating business concerns and investment remains weak. If consumption begins to falter, the Fed cuts again to try to bolster the economy.
Our Take: The Fed should remain on hold, but they now have a history of deviating significantly from their own forecasts. It would not surprise us to see one more rate cut of 25 bps in 2020 but believe that raising rates will be challenging with growth set to slow. The balance sheet should continue to inflate with the Fed remaining active.
Domestic Political Risk
Current Status: The impeachment process is proceeding yet the government continues to function, with a recent budget agreement seemingly avoiding another shutdown.
Upside Case: The government remains open and functioning. Investors and consumers do not alter behaviors because of politics.
Downside Case: Uncertainty surrounding the outcome of the presidential election (and potential policies associated with the outcomes) cause investors and consumers to pull back on spending, imperiling growth.
Our Take: If the election outcome remains as uncertain as it stands now, then investment and consumption would remain cautious until the election concludes, a net negative for economic growth. We currently see no reason to think uncertainty will abate significantly in advance of the election but concede that predicting elections can prove challenging for even the best political scientists and pollsters.
Note: Economic Insights will not publish over the next two weeks. We will return during the first full week of January. Happy holidays!