Global Strategy Outlook: Sequencing the Cycle in 2020

At first glance, the investment outlook for 2020 should be straightforward. Morgan Stanley economists believe the simultaneous easing of trade tensions and monetary policy will offer a late-cycle lift for the global economy. Their forecast calls for 3.2% global GDP growth next year, followed by 3.5% in 2021.

In reality, the picture is distorted by high valuations in many markets, disparate regional cycles and a recovery that relies on continued progress in trade negotiations. “We think that 2020 will be about an uneven global recovery colliding with uneven valuations," says Andrew Sheets, Chief Cross-Asset Strategist. “For this reason, sequencing the cycle is our key theme for the year ahead."

This “sequencing the cycle” strategy means being more aggressive in better-valued markets with early-cycle upside and more defensive in pricey markets that have less room to run. It also means staying flexible. “The fact that this outlook could be changed materially by tariff decisions suggests that an outsized level of nimbleness may be required," Sheets adds.

In Morgan Stanley's 2020 Global Strategy Outlook, Sheets and his colleagues look across global asset classes to highlight the best relative valuations for the year ahead.

Broadly speaking, U.S. risk assets are already fairly valued, but there are opportunities below the index, and in other regions and asset classes around the world. Here are seven key themes for 2020.

Real Expected Returns Across Major Markets Remain Low
(10 Year Real Expected Returns)

In the U.S., fundamentals will ultimately dictate market outcomes in 2020. “Over the past two years, monetary policy overwhelmed the fundamentals," says Michael Wilson, Chief Investment Officer and Chief U.S. Equity Strategist. With the Fed expected to hold rates steady, valuations take on even more meaning.

Rather than hitch their wagons to the index, investors should watch for rotations between styles and sectors. “We expect the market to vacillate between a pro-cyclical outcome and a defensive one as data comes in and trade tensions and elections evolve," says Wilson, whose team is overweight consumer staples, financials and utilities. “In either case, we think growth stocks could be the relative loser as the crowded source of funds."

We Remain the Most Below-Consensus on Earnings for U.S. Equities
(December 2020 EPS Growth Estimates, %)

Morgan Stanley strategists continue to be bullish on Japan, which they have called the most under-recognized turnaround story in global equity markets. While growth in Japan remains challenged according to the firm’s economists, compelling valuations and improving returns on equity could add up to 9% upside for the benchmark Tokyo Stock Price Index, or Topix. 

Trade tensions and tariffs made 2019 difficult for many emerging markets, but a better ex-U.S. global growth outlook may change that narrative. For 2020, Garner and his team have raised their stance on EM equities from underweight to equal weight.  “EM equities typically perform better during periods of global economic re-acceleration and U.S. dollar weakness. As a result, our earnings forecasts suggest growth of 12% for EM in 2020.” 

Garner has also upgraded Korea to overweight from equal weight as a classic play on a cyclical upturn in global growth and upgraded information technology across Asia/EM to overweight.

Earnings are a major driver of equity markets, but so too are multiples—how much investors are willing to pay for earnings. Europe has long been unloved and undervalued by global investors, but that trend could be set for turnaround next year.

Europe is the only market where strategists see multiple expansion for equities. Several contributing factors, including less uncertainty around Brexit, asset allocation decisions away from negative-yielding bonds and global investor base that is under-indexed to Europe may all boost demand for European stocks. 

“After 85 weeks of consecutive outflows totaling $150 billion, we have just started to see some inflows back into the region," says Chief European Equity Strategist Graham Secker, whose team is overweight value, including autos, banks, miners and UK small caps. “We believe investor positioning is still significantly underweight."

Although central banks around the world are simultaneously easing monetary policy, global bond markets will likely diverge in the year ahead.

Put simply, strategists think U.S. and Japanese government bonds will do better than UK gilts and German Bunds. Of course, the U.S. presidential election could upend this outlook. “Rate markets are forward-looking," says Matthew Hornbach, Global Head of Interest Rate Strategy. “Expectations for policies that might result from the election will affect how Treasury yields evolve."

Global credit markets are on track to close 2019 with the highest returns on record in this cycle, say strategists, but it's been a bumpy road. January accounted for a third of investment grade excess returns and nearly 70% of US high-yield returns.

Looking ahead, investors should expect even more bifurcation. Within developed markets, the credit outlook varies greatly by region, sector and quality.

Emerging-market debt is likely to get off to a strong start in the first half of the year as global investors return to these markets. Consistent with previous calls, cross-asset strategists recommend selling U.S. dollars and buying emerging-market fixed income. “We see slight outperformance of local currency debt as currency gains plus carry drive returns," says James Lord, head of EM Fixed Income Strategy. “Think bullish, but don't get greedy."

Local Currency Bonds May Outperform

Turning to commodities, a common theme is too much of everything. In energy, strategists see a precarious balance in the oil market, with OPEC making additional supply cuts next year to keep oil around $60 a barrel. It's a similar story for natural gas, where supply is ample and demand is soft, implying little upside.

Among base metals, copper retains the strongest fundamentals with the potential for 7% price upside in 2020. Gold has pulled back recently as progress toward a U.S.-China trade deal leads investors to lighten up on this hedge. Strategists expect it to stay in its current range of $1,500.

For more Morgan Stanley Research on Global Strategy, ask your Morgan Stanley representative or Financial Advisor for the full report, “2020 Global Strategy Outlook: Sequencing the Cycle" (Nov 17, 2019). Plus, more Ideas from Morgan Stanley's thought leaders.