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Investing in 2020: A Year to Be Selective

Can markets this year reprise their remarkable performance in 2019? Here’s how to think about positioning your portfolio for 2020.

What a difference a year can make. At this time in 2019, major U.S. stock indices had logged their worst yearly performance in a decade. While the start of 2019 may have felt rocky, investors ultimately witnessed a remarkable year. The S&P 500, the broad U.S. stock market benchmark, rose more than 30% and now sits at or near all-time highs, while the main bond benchmark, the Barclays Capital U.S. Aggregate Index, gained around 9%—both up about three times their long-term annual averages.

Can investors expect an encore for 2020? For now, investment strategists on Morgan Stanley’s Global Investment Committee (GIC) believe that much of the good news may already be priced into U.S. markets, and that corporate earnings and overall economic growth may slow this year.

Yet, opportunities abound for the selective investor. For 2020, investors may benefit from looking beyond the U.S.—in Europe, Japan and emerging markets—where the outlook appears more encouraging. 

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U.S. Growth Headwinds

Investor confidence and optimism are key drivers of markets, but they ultimately tie back to the fundamentals: the economy, monetary policy and corporate earnings. Here’s how Morgan Stanley’s strategists view these influences: 

  • U.S. Economy: U.S. GDP growth in 2020 may slow from last year’s 2.3% to 1.8% amid waning tailwinds from monetary, tax and other key policies that helped power 2019’s performance.

  • U.S. Policy: The Federal Reserve is expected to pause on interest rate cuts, while maintaining accommodative monetary policy to stimulate inflation. That may lead to a weaker dollar, which is good for exporters but can raise consumer prices and offset any benefit from a rollback in tariffs.

  • U.S. Earnings: Corporations face rising costs and shrinking profit margins amid consumer spending levels that are already near peak rates. Earnings of S&P 500 companies may be flat in 2020, compared with the consensus 10% earnings growth forecast of Wall Street analysts, according to Morgan Stanley & Co. Research. 

With these outlooks in mind, Morgan Stanley & Co. forecasts the S&P 500 to end 2020 at 3,000—slightly below where it started the year. For U.S. portfolios, selectivity will be key. Morgan Stanley strategists favor defensive sectors, such as utilities and consumer staples, as well as high-quality cyclical companies that can likely beat earnings expectations and that may be undervalued, like financials, energy and industrials. 

More Opportunity Overseas

For greater potential upside, investors may want to look to non-U.S. markets. Here are comparative takes on the fundamentals, from a global perspective:

  • Global Economy: Morgan Stanley & Co. forecasts 2020 global economic growth of 3.4% by the fourth quarter, up from 3% in 2019, with the likely easing of trade tensions adding some lift.

  • Global Policy: The strategists believe that the global economy may be entering a period of long-term reflation, helped by monetary stimulus. Japan recently announced a significant fiscal stimulus package, and the UK is likely to enact one this year, amid a clearer path to an orderly exit from the EU—the realization of which could encourage Germany and France to step up fiscal policy.

  • Global Earnings: Better economic growth should lead to stronger corporate earnings outside the U.S. in 2020. Morgan Stanley & Co. forecasts 2% earnings growth for Europe, 6% for Japan and 12% in emerging markets. 

Non-U.S. stocks also appear relatively inexpensive. Currently, U.S. stocks trade at around 19 times their price-earnings (P/E) ratio, a common measure of valuation, compared with P/E ratios of 13 for emerging markets, 14 for Japan and 15 for European equities. With growth and earnings expected to rebound in those regions, such relatively low valuations may mean more upside. 

Diverging Valuations Suggest Active Management Strategies

Investors may be able to take advantage of valuation discrepancies within and across markets. Just as international stocks seem cheaper than U.S. equities in the current market, value stocks look inexpensive relative to growth stocks, and small-capitalization stocks appear cheaper than large caps.

Such divergences in valuations create a favorable backdrop for active management, where portfolio managers aim to identify potential outperformers and manage risk rather than investing across an index.

Active strategies have outperformed index-tracking strategies during periods of slowing growth. Increased volatility, which Morgan Stanley strategists expect this year, could create more opportunity for portfolio managers to identify undervalued securities. Investors may also find an experienced professional manager helpful when navigating the complexities of international investing. The strategists recommend that investors favor actively managed funds over passive index funds in their portfolios in 2020.

The Hunt for Yield

Fixed income investments are sensitive to changes in interest rates, and Morgan Stanley strategists see U.S. rates staying roughly in the same range in 2020, with the benchmark 10-year Treasury note mostly trading near the 2% level. That suggests investors should focus on nominal yield (the actual interest rate payments you can expect to receive) for income rather than the kind of price appreciation we saw in 2019, when the 10-year Treasury yield declined. (Bond prices typically rise when interest rates fall.)

High-quality investment grade bonds plus alternative investments—like real estate investment trusts and Treasury Inflation-Protected Securities—may be the most compelling income sources in the year ahead.  

Choose Investments Carefully

Overall, Morgan Stanley strategists think 2020 could prove to be a decent year for investors, but it may include some bumps along the way. Diversification will continue to be important.

As 2019 showed, a year can mean a significant difference in returns, but investors should be prepared for mixed results in 2020. Morgan Stanley strategists expect to make more short-term tactical and potentially contrarian calls amid shifts in policies and growth outlooks around the world. A Financial Advisor can help you position your portfolio to potentially benefit from Morgan Stanley strategists’ latest recommendations while aiming to keep your long-term wealth plan on track.

This article is based on the Global Investment Committee’s 2020 Outlook, featured in January’s “On the Markets.” Ask your Morgan Stanley Financial Advisor for a copy or find a Financial Advisor.