2020 Outlook: Fasten Seatbelts as Election Year Could Help Dial Up Volatility

Volatility could return to the picture in 2020 as the U.S. election approaches even while Brexit and China trade issues continue to spin their webs.

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Key Takeaways

  • After some stability in 2019, volatility could roar back as election approaches

  • Trade, Brexit still likely to be big stories in coming year

  • Anticipation of a less-active Fed might have implications for 2020 markets

Investors traveled a relatively smooth road in 2019 where almost every strategy seemed to work, but they might want to grab a pair of hiking boots before too long. The 2020 path looks like it could be paved with rough flagstones instead of glossy marble.

That’s doesn’t mean stocks can’t continue rising in the new year. Ultimately, no one knows if that will happen, though many analysts sound bullish. What it does mean is that volatility, often absent in 2019, could come roaring back as 2020 advances and investors face a U.S. presidential election, further trade war travails, and potentially less active assistance from an accommodating Fed.

“One thing to highlight right away is there will likely not be a summer slowdown in volume in 2020 where everyone goes to the Hamptons,” said Shawn Cruz, trader business strategy manager at TD Ameritrade. “I wouldn’t expect that, because as you get closer to the election I expect a lot of rhetoric and headlines around China trade to still be flying around, and that will drive volatility. I expect general campaigning and different proposals and what candidates say could drive volatility as well leading into elections.”

Election Year Warning: Don’t Believe the Hype

Before going further down any roads, there’s one thing investors are likely to hear a lot about in coming weeks but shouldn’t give much attention. You’ll read that markets tend to do such-and- such in a presidential election year because of what happened over the last few decades in similar years. That’s kind of like astrology: Fun to think about but not necessarily relevant to your life (or in this case, your portfolio). What happened in 2016 or 1976 happened for a reason, and the reasons likely changed in the last four or 44 years. 

“You have to focus on the day-to-day stuff and not get too caught up in the election,” said JJ Kinahan, chief market strategist at TD Ameritrade. “The markets won’t pay close attention to it until August.” He thinks tariffs are the number-one issue to watch in 2020, and it looks like a potential phase one of an agreement with China could get ironed out here in late 2019.

There’s likely still a ways to go as the two countries grapple with tough issues they’ve been unable to solve in nearly two years of talking. That said, Kinahan expects a “tariff conclusion” in 2020 due to the pending U.S. election.

Volatility’s Potential Impact

Volatility, as measured by the Cboe Volatility Index (VIX), had its ups and downs in 2019, but never managed to stay really high for really long. That could potentially change in 2020, especially as the year rolls along and the November election approaches.

If volatility does climb from current levels of around 14 for VIX, that could potentially drive investors to seek more defensive places where prices sometimes move a little less quickly.

You could arguably already see this developing late in 2019, when a move away from growth and toward “value” stocks appeared to take root. Sectors where some analysts say they currently see value include Financials and Health Care, which trailed the broader market this year.

In volatile periods, sometimes investors lighten their stock allocation and look for what they hope is more stability in fixed income. That could be one reason why many analysts don’t expect bond yields—which ended 2019 in a rut—to achieve much of a rally in 2020. Estimates for the 10-year yield top out at around 2.25% for the coming year, compared to around 1.8% in mid-December, and a lot of that depends on whether overseas economies can rebound.

VIX and 10-year yield throughout 2019

FIGURE 1: FALLING YIELDS, BOUNCING VIX. As we look ahead to 2020, it's important to note from where we came. In 2019, the Cboe Volatility Index (VIX - candlesticks) spent several months in the low-to-mid teens, below its long-term average around 18 (purple line). Meanwhile, interest rate yields, including the yield on the 10-year note (TNX - blue line) spent much of the year drifting lower, bottoming out below 1.5%, and closing the year in the 1.8% range. Data source: Cboe Global Markets. Chart source: The thinkorswim® platform from TD Ameritrade. For illustrative purposes only. Past performance does not guarantee future results.

Fed Seen on Sidelines, Mostly

The U.S. central bank looks like it might play a less vital role in 2020 than in the 2017-2019 era.

The Fed raised rates by 25 basis points four times in 2017 and then four more times in 2018. That helped send 10-year Treasury yields to well above 3% by late 2018 before the Fed switched course and lowered rates 75 basis points between July and October 2019. The trade war with China and slower than expected overseas growth likely played into the Fed’s strategy.

The Fed left rates unchanged at its December meeting, but it might not be quite done yet. According to CME Group Fed funds futures, there’s about a 30% chance that the Fed will cut rates one more time by 25 basis points between now and next July, to a range of between 1.25% and 1.5%.

Those expectations fell from around 40% after the Fed’s December meeting. “The Fed is largely expected to hold on for most of 2020,” Cruz said.

The Fed’s expected absence—which often occurs during presidential election years when officials there grow reluctant to change rate policy out of fear of appearing to favor the incumbent or challenger—could change the market’s character in 2020.

Throughout 2019, Fed policy gave the market a nice tailwind. You might say the Fed had the market’s back, something Fed Chairman Jerome Powell arguably made clear when he said the Fed would attempt to keep the expansion going as long as possible. To investors, that sounded like a promise to lower rates more in case the economy ran into trouble. Stocks quickly jumped to new records in the last few months of the year.

This coming year, the safety net might still be in place, but lack of Fed action might mean less chance for big rallies. Many analysts look for the SPX to gain in 2020, but in the high-single digits, closer to its long-term average. 

Think of it this way: The SPX rose more than 25% in 2019 despite flat to lower earnings growth, in part because the Fed was going at full throttle by mid-year making conditions easier for companies and consumers to borrow. This possibly contributed to the strong growth in consumer demand in the second half of the year.

In 2020, by contrast, the Fed is likely to be less of a factor, meaning investors might have to rely more on fundamentals to determine market direction.

“Throughout 2019, we were kind of rallying on one rate cut to the next,” Cruz said. “Now, when you look at the Fed being on hold, it could move the microscope back to actual earnings and data.” 

So what do the fundamentals look like headed into the first year of a new decade?

Earnings Rebound?

After earnings growth really tailed off in 2019, they have a chance to bounce back at least a bit in 2020 thanks in part to easier comparisons and possibly stronger economic growth, analysts say.

Earnings could rise a solid 8.2% in 2020, vs. just 0.6% in 2019, according to S&P Capital IQ consensus estimates. The firm expects sector earnings leaders in 2020 to include Energy, Industrials, Materials, and Consumer Discretionary. Weak links could include Real Estate and Financials. Oddly enough, Energy, Materials and Industrials were among the weakest earnings performers of 2019.

A few months ago, you might have heard some talk about a possible 2020 recession. That’s never out of the question, because recessions are a normal part of the economic cycle. However, it seems like several economists have dialed back the recession talk in recent weeks as economic data continues to look healthy and some signs emerge of overseas economies perking up a bit. Some analysts expect emerging markets to outpace U.S. and other developed market growth in 2020. China’s GDP growth has been slowing, however, and might fall below 6% in 2020, analysts say.

The Fed on Dec. 11 predicted U.S. GDP growth of 2% in 2020, inflation of 1.9%,  and unemployment of 3.5%. Those figures aren’t far from the current levels. The Fed’s latest “dot plot” of rate expectations shows rates unlikely to rise in 2020 but also not likely to fall. The current Fed funds rate is 1.5% to 1.75%.

If the Fed’s projections turn out to be right and the U.S. economy continues its slow but steady growth without inflation or higher interest rates, what does that mean for the stock market?

“From an investor standpoint, if the base case is an economy growing moderately, inflation in check, and interest rates not picking up to any meaningful degree, that seems to bode well for value-oriented stocks of the world, which had been left behind for many years and are starting to outperform as economic sentiment improves,” said Patrick O’Hare, chief market analyst at Briefing.com.

The sectors where O’Hare thinks investors might seek value are Financials and Health Care, both of which, “have less demanding valuations relative to historic averages,” O’Hare said.

For the broader market, the better than 25% SPX gains through mid-December this year with very little earnings growth means “you could argue that we pulled forward some of the returns this year” and “suggests investors should expect somewhat more modest returns in 2020,” O’Hare said.

“The good news has been priced in, somewhat,” O’Hare added. “If interest rates remain near the status quo of around 2%, the market is probably going to do OK.” 

Trade Truce Could Be “X” Factor for 2020 Earnings

Growth might exceed that if one huge overhang goes away. 

“There is an old stock market adage that ‘prices lead fundamentals,’” said Sam Stovall, chief investment strategist at research firm CFRA. “And the answer is likely found in the expectations for some sort of trade truce. Until details of the deal are revealed, however, along with prospects for continued conversations, EPS estimates are likely to undershoot potential.” 

The fact that stock prices are gaining even as EPS projections decline, he added, could indicate that investors think that if current EPS estimates are wrong, it’s because they’re under-estimating actual growth.

One sector trend to consider watching is whether small-cap stocks can achieve some traction, which might be interpreted as a bullish sign. They’ve been outpaced by large-cap growth stocks in recent years. Strength in small-caps can sometimes indicate underlying economic vigor. Also, transports and biotech are often considered barometers for the broader economy.

The elephant in the room is the presidential election. So much could hinge on who emerges as the main challenger to the incumbent and how the debate shapes up as summer turns into fall. No one has any idea how all this might play out or the potential market implications, so it would be fruitless to predict anything now.

Consider keeping a careful eye on the Health Care sector, especially if a candidate emerges who proposes to do away with private insurance. That could be a major blow to Health Care stocks. Technology stocks also might be in the hot seat as the campaigns move forward, especially if candidates on either side turn the focus to issues like antitrust and privacy, both of which have come under Washington’s microscope from both parties in recent years. Remember, though, that a lot of campaign season promises don’t necessarily see the light of day after the election.

What Could Go Wrong?

A lot of other things could also keep volatility hopping in the new year. Some possible tipping points include lack of progress on the next steps in a trade deal with China, the potential of Brexit finally happening, or slower than expected earnings growth. The chance of a U.S. recession can’t be completely written off, even if analysts seem to believe that’s less likely.

One concern is that business confidence appears to remain soft as 2020 approaches. The latest Business Roundtable quarterly economic outlook survey tracking CEO plans for capital spending and hiring as well as their expectations for sales over the next six months slipped slightly. “CEOs remain cautious in the face of uncertainty over trade policy and an associated slowdown in global growth and the U.S. manufacturing sector, which is currently contracting,” the Business Roundtable said in a news release.

“Business spending is soft due to tariffs,” Kinahan said. A solution to the tariff situation might help that metric.

A U.S. jobless rate now at 50-year lows is also worth a close watch moving forward.

“The employment market is the biggest wildcard,” Kinahan said. “If employment continues to look like it does now, the market will likely do well. If employment turns lower, you might see the retail or housing sectors turn down.” 

To sum up: 2020 could be a year of healthy earnings growth and stable monetary policy, but also one of caution, uncertainty, and election-related noise. Buckle up; it could be an interesting ride.


Key Takeaways

  • After some stability in 2019, volatility could roar back as election approaches

  • Trade, Brexit still likely to be big stories in coming year

  • Anticipation of a less-active Fed might have implications for 2020 markets

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