The biggest risks for stocks in 2020

Outlook for stocks ahead of 2020 election
History suggests that the market will be bumpy in the first half of 2020 but ultimately settle down once it's clear who the Democratic nominee will be.

Optimism over a “phase one” trade deal between the United States and China is pushing stocks to record highs in the final days of the year. But Wall Street banks still believe trade is one of the biggest risks for markets in 2020.

That theme, which drove markets in 2019, seems hard to shake.

Although the world’s two largest economies are inching closer to signing a preliminary deal, many investors remain skeptical following the carrot-and-stick approach on the trade this year.

Trade war

The trade war poses two risks, according to Wall Street banks.

On the one hand, Washington and Beijing have only agreed to a “phase one” deal so far. Once this agreement is signed — if it is signed — a full-blown deal still needs to be negotiated. And with more trade talks come a prolonged risk of negative headlines and renewed tariff threats.

An escalation of the trade war could lead to significant economic harm, particularly hurting business spending and employment, economists at Morgan Stanley wrote in a recent analyst note.

Although the trade war with China is arguably the most important hurdle to clear for global growth, America has also just threatened more import tariffs on its European partners. The question of auto tariffs on Germany, for example, will continue to loom next year. President Donald Trump also renewed the threat of steel and aluminum tariffs on Brazil and Argentina at the start of December.

On the other hand, trade developments could also could surprise markets with positive developments. That could pose a risk to investors expecting slower progress in negotiations.

For example, Bank of America analysts said in a recent note that a substantially larger trade deal could make its 2020 forecast appear conservative.

Recession or rebound?

Recession risks abated in the second half of 2019, but the longest-running expansion in US history will have to come to an end at some point. After a buoyant annualized GDP growth rate of 3.1% in the first three months of the year, the economy slowed to a rate of 2% and 2.1% in subsequent quarters. Economic growth is expected to slow further in 2020.

At the same time, global manufacturing is expected to be past its trough. The sector has been hurt by the trade war, both globally and in the United States, which weighed on demand and material prices. But the data has begun to improve, which could help stocks higher.

“The best environment for stocks is when the ISM [manufacturing index] has deteriorated and fallen below 50 but then reverses course and starts to improve,” said Jonathan Golub, chief US equity strategist at Credit Suisse.

An uptick in global trade and a reduction in political uncertainty could give this market an additional boost. Morgan Stanley’s economists expect global growth to improve at the start of 2020, even though they expect a recovery to be muted.

Presidential election

The US presidential election isn’t until November, but it is a political risk investors will keep an eye on. Much depends on the Democratic candidate challenging President Donald Trump. A more moderate Democrat could reduce political uncertainty, the BofA analysts said.

A sharply left-leaning candidate could represent risks for specific sectors, as well as the country’s fiscal balance. Democratic contender Elizabeth Warren, for example, proposed to ban all fracking. Wall Street is certain a Warren administration would be bad for energy companies. At the same time, Warren could also be bad for business for banks and investment firms.
“I would expect a risk-off sentiment to possibly develop and take hold by late summer or early autumn ahead of the US presidential election, as investors bring political risk sharply into focus.” said John Herrmann, economist and director of interest rates strategy at MUFG.

Meanwhile, investors are wondering what would happen to fiscal stimulus in the next administration. Trump’s 2017 tax cuts boosted the economy and the stock market in 2018, for example, but its effects have worn off now.