2020 Global Market Outlook
January 14, 2020
Executive Summary
Investors were delivered exceptionally strong returns last year and judging by the equity markets’ performance in December and early January 2020, optimism about the future of the US economy is high. This is in stark contrast to a year ago when fears of a trade war, rising interest rates and accelerating inflation as a result of tariffs imposed by the Administration were fueling recession predictions.
Presidential election years are usually characterized by uncertainty and 2020 looks no different. The first votes in the Democrat primary cycle, the Iowa Caucuses are less than three weeks away. Voters will have disparate choices of how the US economy should be run and the role of government in citizens’ lives. Democrats have a choice of several competing visions as they select a challenger for President Trump.
We believe three areas of interest and concern will influence markets this year:
- The US Presidential Election and the US economy
- Implementation of the Phase One trade agreement with China and the USMCA
- Iran’s nuclear ambitions
The US Election and Economy
Four years ago, Donald Trump was an unknown quantity, running an unconventional Presidential campaign with relatively narrow Republican party support. His message resonated with a segment of the electorate, but in late 2015, no one was picking him to win the nomination, let alone become President.
In his first term, Mr. Trump has remained focused on the issues he raised on the campaign trail and his support within the Republican Party is now at 90%.[1] Skepticism about the ability to accomplish his stated goals has largely been eliminated for Republicans. Democrats remain opposed to not only his policies but also his style of governance.
The US economy under Mr. Trump’s stewardship exhibited strong growth in 2017-2018. In 2019, tariffs began to negatively impact domestic manufacturing activity and ultimately GDP growth. The levies were designed to bring China to the negotiating table and while they likely subtracted roughly 0.5% from 2019’s GDP growth rate, a landmark agreement with China is scheduled for signing on January 15.
In 1992, James Carville, Bill Clinton’s campaign manager said, “It’s the economy, stupid.” President H. W. Bush was defeated in his bid for a second term by Mr. Clinton, in large part because Clinton’s campaign focused on sluggish economic growth.
2019 saw the rate of corporate earnings growth decline from the previous year. However, in each of the three quarters for which results have been posted, a strong majority of companies beat not only earnings predictions but also revenue targets. Early results from the fourth quarter have continued these trends.
Voters will factor their personal economic well-being into choosing the next President. Unemployment remains at or near 50 year lows and wage growth, particularly among blue collar workers continues to expand at a rate roughly twice that of inflation. Workers at all pay grades are experiencing real wage growth. Job openings remain greater than the number of workers available to fill them, which is fueling stronger wage expansion for lower skilled workers.
We expect strong US economic growth to continue this year characterized by an acceleration of annual corporate earnings growth rates as trade issues are resolved. Without a compelling economic version from Democrats we believe there is a good probability President Trump will be reelected.
Trade
The Phase One agreement with China to be signed on January 15 entails no change in the existing US tariff regime. China, however, will eliminate tariffs on many US manufactured goods. Additionally, the US has received a commitment from the Chinese to significantly increase purchases of US agricultural products.
We noted army worm infestations in the Chinese corn crop last spring, which have devasted yields.[2] Concurrently, African Swine Flu has virtually eliminated domestic pork supplies.[3] Pervasive shortages in these fundamental commodities can only be alleviated by international purchases.
One issue that could stifle projected Chinese agricultural purchases is the ability of US producers to meet significantly greater demand. Additionally, there is skepticism surrounding Chinese statements of intent vs. actual performance.
Nonetheless, exports of US manufacturing and agricultural products are projected to grow by $200 billion over the next two years under the Agreement. Agricultural purchases should account for $40-$50 billion of the total.
The potential for mushrooming demand led to President Trump’s admonition in an impromptu Oval Office press conference last month that, “And I say, affectionately, the farmers are going to have to go out and buy much larger tractors, because it means a lot of business, a tremendous amount of business,”[4]
The next phase of negotiations appears unlikely to be completed before the US election for two reasons. First, the Administration will be well occupied ensuring that the Chinese follow through on their Phase One commitments and second, implementation of the USMCA will require significant attention.
The House of Representatives passed the USMCA December 19. Senate committee hearings are underway with final approval expected by late January.
Estimates of the impact of the USMCA have focused on an expected 0.5% increase in GDP and the creation of roughly 175,000 new jobs. Dairy farmers and other producers will be able to increase exports to Canada as tariffs and import restrictions are reduced going forward.[5]
We expect implementation of the USMCA to quickly add to US GDP and total employment. If Chinese Phase One compliance is forthcoming, further expansion of agricultural and manufacturing exports to China should create a significant, positive US economic impact. Ripple effects from both agreements have the potential to provide meaningful upside surprises for the economy.
Iran
Iran has maintained an adversarial relationship with the US since 1979. Except for a period of tacit truce during the 2017-2019 struggle to eliminate the ISIS Caliphate in Iraq and Syria, Iran has continued to sponsor direct and indirect attacks on US persons and property.
Iran has actively pursued development of a nuclear device, deliverable by missile to areas within the Middle East and ultimately, most areas of the globe, including the US. The 2015 JCPOA was intended to contain Iran’s nuclear program but addressed neither the country’s ongoing export of terror nor its ballistic missile development.
In May 2018, President Trump announced that the US was withdrawing from the JCPOA. The reasons cited were a conviction that Iran was not adhering to the terms governing uranium enrichment and an inability to effectively enforce provisions of the Agreement.
In late 2018, the US announced an embargo on Iranian oil exports and sanctions that would be imposed on countries that continued to purchase Iranian oil after May 2019. In addition, sanctions were imposed directly on Iran and several Iranian individuals. As these sanctions began to severely impact the Iranian economy, inflation has increased exponentially[6] as has bellicose anti-American rhetoric from the country’s leaders.
During the Fall of 2019, Iranian sponsored activity aimed at sabotaging oil traffic in the Persian Gulf began to increase. An attack on a Japanese tanker and a missile attack on Saudi Arabian oil production were part of an increase in belligerent activity. The downing of a US drone and frequent attacks on US facilities culminated with the late December death of a US contractor in Iraq. Shortly after that incident a Shia militia attempted to invade the US embassy in Baghdad.
The US did not directly respond to numerous provocative actions over the second half of 2019, except to tighten and widen sanctions. However, the death of the American contractor was a red line that led to the targeted killing of Qasem Soleimani early January 3, Iraq time. A retaliation by the Iranians followed several days later. On January 8 an Iranian surface-to-air missile shot down a Ukrainian civilian airliner, killing 179 non-combatants.
After initially denying any complicity in the crash, on January 11 the Iranian government admitted it had mistakenly attacked the aircraft, expanding previously existing anti-government protests. The US has expressed written, specific support for the protestors in Farsi, an unprecedented action.
President Trump has stated in clear terms that Iran will not be permitted to obtain a nuclear weapon. Trump has also unequivocally stated that the US does not seek war, but that further attacks on US personnel will be met by a disproportionately severe response.
In the wake of the latest crisis, additional sanctions have been imposed on Iran. The US has called upon signatories to the JCPOA, particularly the UK, France and Germany, to join the US in negotiating a new, more comprehensive agreement. The US seeks an agreement that addresses Iran’s terrorist activities and missile development program in addition to prohibiting it obtaining nuclear weapons.
We expect that Iranian domestic unrest will continue, possibly threatening survival of the ruling regime. President Trump has issued a direct warning to the regime to refrain from further executions of protestors. It is reasonable to expect that a concerted effort to compel Iran to surrender its nuclear program will be ongoing this year and that any military activity against the US or its allies will be met with overwhelmingly forceful retaliation.
Conclusion
In the past year, the US economy has continued to expand despite a slowdown in manufacturing activity attributable to tariffs. Two important trade developments, a Phase One agreement with China and final passage of the USMCA are likely to largely eliminate these drags on growth.
Impeachment as an issue will likely fade after an expected acquittal of the President by the Senate. Should the US economy continue recent trends, President Trump will likely be reelected. Of perhaps even greater importance, however, is whether the House returns to Republican control and the Senate remains in Republican hands. Voters will have an unusually stark choice of visions this fall.
Tension in the Mideast between Iran and its regional foes is unlikely to dissipate as sanctions continue to exert crushing economic pressure on the Islamic Republic.. Open military conflict is a possibility, but the overwhelming strength of the US combined with its allies Israel and Saudi Arabia would make Iranian success unlikely. Attempts to influence oil markets with disruptive behavior in the Persian Gulf and Strait of Hormuz will be dealt with quickly as will any supply shortfalls. The US and Saudi Arabia both have excess capacity to overcome supply constrictions.
Investors are clearly optimistic as 2020 dawns, but as always, there are unforeseen and unknowable events that could shatter expectations for another positive year. Adherence to a solid long term plan and avoidance of media noise will support the discipline necessary to remain invested during inevitable selloffs in the equity markets. Underlying economic strength and new trade configurations argue for a good year, but it is perhaps when the outlook is rosiest that investors must be most vigilant.
Byron A. Sanders
Investment Strategist
©2020 Artifex Financial Group LLC
[1] “Trump support among Republicans reaches all-time high in poll,” www.thehill.com, January 6, 2020.
[2] “China's northeast cornbelt likely to be hit by fall armyworm in 2020: government report, www.reuters.com, December 26, 2019.
[3] “China’s African swine fever outbreak drives 150 per cent jump in pork imports,” www.scmp.com, December 23, 2019.
[4] “Doubts Emerge About Chinese Agricultural Purchases of $40-$50 Billion After Initial Deal, “How Would They Do It?” www.farmpolicynews.illinois.edu, December 15m 2019.
[5] “MEXICO–CANADA TRADE FACT SHEET Agriculture: Market Access and Dairy Outcomes of the USMC Agreement,” ustr.gov,.
[6] “Iran Inflation Rate,” www.tradingeconomics.com, data as of December 2019.
