At Infrastructure Capital Advisors, we believe that many investors were too focused on the trade war in 2019, and not focused enough on global monetary trends. In our view, these trends were the key drivers of the global economic weakness last year and, looking ahead, we believe they will be a driver of much improved global growth in 2020.
Improved Global Growth Picture For 2020:
We have observed that there is usually a 6 to 12 month lag in monetary policy effects, and believe that monetary trends from 2018 contributed to a macro environment of global economic weakness in 2019. In 2018, 10 of the world’s 15 largest economies were tightening monetary policy, representing over 80% of global GDP. During the last eight months of 2018, the dollar also appreciated 8%—forcing global central banks to defend their currencies with tighter policy.
Conversely, heading into 2020, 14 out of the 15 largest economies are easing, representing 95% of global GDP. Further, there has been an acceleration of activity globally in the last 6 months in sympathy with Fed easing. Japan has announced over $100 billion of annual new stimulus over the last month, China has enacted a $280 billion tax cut, other Asian countries are also increasing spending and the lower US corporate tax rate continues to drive growth.
Monetary policy is key
Given the easing trend in monetary policy, we would expect global economic growth to accelerate by mid-year 2020. Easing should propel the US economy to the 2.5% run rate by mid-year, up from the current 1.5-2.0% run rate, with consensus growth for 2020 at 1.8%. In China, the emergence of the novel coronavirus will have an impact on GDP. However we believe that the country’s effort to contain the virus and the fact that we are nearing the end of the flu season will result in the effect being relatively short term. In addition, China is likely to attempt to offset the economic impact of the virus with incremental monetary and fiscal stimulus.
Based on improved global growth, 10-year treasury rates should gradually rise into the 2-2.5% range in 2020, but will be capped by $45 trillion of global pension assets. The dollar should also weaken against most major currencies during 2020 as the global economy continues to improve.
Ultimately we believe we are early to mid-cycle, not late cycle. The 2019 global slowdown reduced inflationary pressures and will put the Fed on hold for the intermediate term. In addition, we believe the Fed has de facto raised its inflation target, which will make the economy less cyclical.
Investing Implications:
Equity Markets: S&P 500 Could Reach 3,800 by Year End
If US and global growth accelerates, cyclical sectors such as financials, industrials, energy and tech could outperform, while interest sensitive sectors including utilities, REITs, telecom and consumer staples could underperform. The S&P 500 may close out 2020 at over 3,800 (based on a 2021 multiple of 18x), representing about 15% upside from here.
We believe that the S&P 500 multiple will reach higher levels than in the past due to higher EPS growth driven by the corporate tax cut. Earnings growth primarily comes from investment of retained earnings not from organic sales growth.
Fixed Income Markets: Preferred Stocks are Particularly Attractive in 2020
In a rising interest rate and stock market environment, higher spread products such as preferred stocks and high yield bonds should perform well, while treasuries, muni bonds and investment grade bonds could underperform or decline. We believe that there is a strong case for active management of fixed income securities as call risk and credit risk require active management or at least smart beta metrics.
US listed preferred stock could be a particularly attractive asset class during 2020, as the asset class currently offers an average yield of over 5.5%. We favor preferred stock over high yield bonds, as the issuers of preferred stock are almost always publicly traded companies with relatively strong senior credit ratings. Since preferred stock is junior to bondholders and other creditors of the issuer, the securities offer yields significantly higher than investment grade bonds. Most large publicly traded companies that issue preferred stock are committed to maintaining an investment grade credit rating as they have investors, customers, regulators or other constituencies that value companies with strong credit ratings. High yield issuers are often private companies with less motivation to maintain or improve their credit profile.
Oil Markets: WTI to Trade in $50-70 Range
WTI oil should trade in the $50-70 range during 2020, as improved global growth may lead to an increase in demand. Oil prices should strengthen later in the year as we move into the peak driving season and the world economy continues to improve. A weak dollar and slowing US production, as US producers cut back on CapEx in response to investor pressure to increase free cash flow and net earnings, will also support oil prices.
Further, with WTI oil currently at about $50, all of the Middle East related risk premium has been removed and fears of a slowdown in oil demand as a result of the coronavirus outbreak in China are reflected. The assassination of General Soleimani was met with a limited response by Iran and highlighted the fact that only a limited number of response scenarios would result in a significant reduction of oil supply. The US controls no production in the region and any disruption of tanker traffic is likely to be temporary.
Energy Stocks/MLPs Make the Transition from Growth Stocks to Value:
We expect more acquisitions of MLPs by private equity in 2020 after a number of transactions were completed in 2019.
Energy companies, including drillers and pipelines/MLPs have responded to weak stock prices by limiting capital expenditures, reducing debt and are starting to buy back shares. In addition, pipelines/MLPs are very undervalued relative to private market values.
U.S. MLPs in the pipeline and storage business are benefiting from the expansion of oil, natural gas and natural gas liquid production from shale. The large increase in production has turned the United States into a net exporter of energy. This has created a large opportunity for US pipeline and storage companies to expand pipelines, storage facilities and export terminals. In addition, most of the large companies have improved their financial profile since the crash in energy prices in 2015 by reducing leverage, increasing distribution coverage, and initiating share repurchases.
