Why end-of-year rally is no guarantor for 2020

The year 2019 was kind to investors of all asset classes. The S&P 500 rose by 30 percent, which has happened only eight times since 1930. Global stock markets showed increased volatility, and ebbed and flowed in line with the fortunes of the US-China trade talks. They had their biggest rally since October when it became apparent that the two countries had edged closer to agreeing on the first phase of a trade agreement.

Commodities rallied too, with prices fluctuating in line with the progress of the trade talks. Brent rose close to 25 percent between Jan. 1 and the end of December. Its performance ranked third in the commodities space. Volatility was high.

The drivers were the global outlook on trade and the ability of OPEC+ — a cooperation arrangement between the Organization of the Petroleum Exporting Countries and 10 non-OPEC allies — to curtail production to balance markets. Toward the end of the year, there was also increased demand from refiners to distil grades complying with International Maritime Organization regulations for low-sulfur fuels in the shipping industry.

The drone and missile attacks on Saudi Aramco facilities in September led to a temporary spike, but things quieted down quickly when it became clear that the company was able to restore production and capacity in short order.

It seems that oil no longer serves as an indicator for geopolitical tensions in the Middle East, which can partially be explained by the fact that increased non-OPEC supplies have outstripped demand growth for several years now.

In the end, 2019 proved to be a positive year for investors.

Cornelia Meyer

The global economy still grew, all be it at a slower pace than projected at the beginning of 2019. The economies worst hit by the downgrade were open trading economies such as Germany, Japan and Australia. Germany’s export industry is dependent on China for capital goods and cars. Australia’s economy is largely resource driven, and its fortunes always move in lockstep with China’s economy.

Central banks engaged in further interest rate cuts and quantitative easing. At the beginning of 2019, no one would have predicted that the Federal Reserve would cut rates three times this year. In 2020, we may expect several big central banks to keep rates stable unless economic forecasts surprise.

The European Central Bank is under the new leadership of Christine Lagarde, who has for some time advocated that central bank interventions need to be supported by fiscal policies. She has a point in as much as many economies, such as Germany’s, would benefit from structural and infrastructure investments.

Central banks averted a meltdown of the global economy after the 2008 financial crisis. But their tool kit is increasingly limited by bloated balance sheets and ultra-low to negative interest rates.

The People’s Bank of China (PBOC) may be the exception. The latest measures to unify rates for Chinese borrowers can be seen as a de facto stimulus. Creating a level playing field for domestic borrowers may also be a tool for the PBOC to start addressing bad debt in the system.

This brings us to the risks for 2020 and beyond. While markets surprised on the upside in 2019, we should not take smooth sailing for granted. There are several structural and event risks on the horizon.

Low interest rates have led to a debt bubble at the government, company and household level. This will have ramifications when interest rates rise again. They have also led to other asset bubbles, particularly in equities and real estate.

In the age of ultra-low to negative interest rates, dividend-yielding blue chip stocks have taken the place of fixed income. While the dividends may provide the desired returns, investors are still exposed to much higher risks associated with shares.

We may have reached the first phase of the US-China trade deal, and President Donald Trump may keep things calmer on the trade front during an election year. But the last two years of trade disputes have left behind what the head of the International Monetary Fund called the generational impact of broken supply chains.

It is not just the supply chains that should worry us; it is also the weakening of the global multilateral trade architecture. The World Trade Organization (WTO) has been much weakened by the last two years of trade disputes and bilateral approaches.

Trump’s continued refusal to confirm the appointment of judges to the WTO’s Court of Appeals hollowed out the organization’s ability to mediate trade disputes, which is one of its most important functions.

The inability to reach an agreement on a price for carbon trading during negotiations in Madrid showed how difficult it is to find a global consensus without the world’s largest economy at the negotiating table.

The US withdrawal from the Paris Agreement on Climate Change signifies yet another erosion of the multilateral infrastructure. Inaction on the regulatory level will over time also heighten the event risks stemming from climate change, such as wild fires and flooding. These events have a huge economic impact.

Other event risks for 2020 are Brexit and the US election. The UK will leave the EU on Jan. 31. It will matter to both sides whether the UK government can negotiate a trade deal by December 2020. Failing to do so would result in a no-deal Brexit with all its consequences. In that context, we should not forget that the EU is the world’s largest economic bloc, and that the UK ranks 5th in the league table.

The dollar performed well in 2019, and looking at interest rate differentials, it will most probably hold its position. The event risk in the US is the presidential election, depending on the Democratic nominee.

In the end, 2019 proved to be a positive year for investors. Looking forward, we should not take recent asset price rallies for granted, and be aware of slower growth rates, continued trade disputes, fewer tools of central banks to counteract crises, the continued weakening of the multilateral architecture and several potential event risks.

• Cornelia Meyer is a business consultant, macro-economist and energy expert. Twitter: @MeyerResources