Will US stocks rock the boat in 2020? – Special Report

Christina Parthenidou, XM Investment Research Desk

US stocks had a spectacular rally in 2019 with little volatility despite trade tensions, monetary easing and geopolitical conflicts, with the S&P 500 stock index adding a whopping 27% to its value during the year to trade at fresh uncharted waters. As the overstretched increase and the unstoppable print of record highs raise concerns that a cliff edge may be around the corner, there are reasons to believe that 2020 may be another decent year or at least not a damaging one, even though some weakness could be expected.  

Trade story to be continued

For the second half of 2019, the US and China were locked in a bitter trade battle which hit the manufacturing sector especially hard before tensions eased in November following the phase one trade deal. According to the phase one trade agreement, the US will roll back some of its levies in exchange for firm commitments by China to more than double its purchases from the US and reform its practice of forcing US companies to transfer their technology to Chinese markets. Of course, the deal did not put an end to the trade war and some doubts remain if China will be able to fulfill its commitments, but something is better than nothing and the move will provide a breather to US farmers and tech companies.

In terms of market reaction, traders have largely priced in the positive prospects of the phase one deal. So, what remains to be seen is the impact on economic data and corporate earnings, which are likely to be affected by the progress in phase two of the trade talks later in the year. Expectations are for tougher negotiations and a spark in tensions because of the thornier topics involved in the agenda such as how China will adjust its policy on foreign companies. If the two sides fail to find common ground or a stronger battle starts with Europe, with the data revealing further weakness in the US economy, traders are expected to shift funds away from tech and commodity stocks and vice versa.

In the case of a serious deterioration in economic figures and specifically in the event consumers, which control more than 70% of the US economic growth, fail to balance the weakness in the business sector, the Fed could resume monetary easing to support the US stocks although it pledged to stand pat on interest rates in 2020.

US elections to be the highlight of the year

The US presidential elections on November 3 will be the hot event of 2020. Since Trump’s impeachment has a low probability of materializing given the fact that all Democrats, Independents and more than 20 Republicans need to vote in favor of it in the Republican-held Senate. Therefore, the most likely scenario is that Trump will compete for a second term. But the battle against a Democrat may not be a piece of cake, especially against populists Bernie Sanders and Elizabeth Warren or centrist Joe Biden who all seem to be polling at the top so far, though at tight margins.

Should Trump get re-elected, Wall Street could print gains on hopes that income and corporate taxes may remain low if Congress allows it. At the same time, given Trump’s protectionism and his “make America great again” approach this would also imply more acrimony with trade partners such as China and Europe if US economic growth remains comfortably in positive territory.

On the other hand, Democrats have been opposing the large tax cuts delivered by the Trump administration and could push efforts to increase corporate taxes but not to previous high levels in case they win the elections. While this could bring some downside to US stocks, plans for more infrastructure and renewable energy investments could benefit construction shares and green companies . Regarding trade, Democrats may not terminate the battle with China and other partners but instead keep applying pressure for the sake of a healthy American job market.

A bitter outcome for Wall Street would be if Democrats win elections but remain divided in Congress, with investors feeling discouraged to put their funds in an uncertain political environment.

Note that in February, markets will get their first clues from Iowa state caucuses on who will be Trump’s opponent, but a clearer picture will be provided in March when larger states will release their own results on the so-called “super Tuesday”.

Nevertheless, if someone looks at historical data, US stocks tend to record gains after US elections take place and hence there is a large probability that they will do so after November 3 this year.

Bonds VS Stocks

The US stock market is over-sized relative to the size of the US economy according to the market cap-to-GDP ratio that has risen above 200%, something that has preceded previous recessions in 2000 and 2007, and investors fear an imminent collapse.

Theoretically, under this speculation, traders could search for safer assets to invest in such as the US Treasuries and, looking at the yields, this is seemingly the right thing to do as the 10-year and 30-year Treasury yields seem to be deviating above the S&P 500 dividend yield again after crossing almost below it recently. Still, the spread is not significant and that may keep some interest in stocks in 2020, especially if the Fed maintains interest rates at current low levels and repo interventions at elevated levels. Note that the S&P 500 stock yield remained stable during 2019 versus the aforementioned Treasury yields which were on a downtrend, giving some advantage to stocks.

Technical outlook

From a technical perspective, the S&P 500 stock index is in overbought waters, increasing the odds for a downside correction. Still, it’s clear that the uptrend has yet to show signs of reversing and with the price fluctuating comfortably above its upward-sloping simple moving averages, any downfall may not appear disruptive unless it happens below 3,000. Meanwhile, the 20-day simple moving average which has been a key support area several times in the past should attract attention first if the price shifts south.