This past year will be remembered as a year of potential risks to a bull market that is now the longest in history. While these risks created some heightened volatility in global markets, they will also form the foundation to our expectations for markets and the economy for 2020.

The much-discussed economic expansion should have further to run, underpinned by accommodative credit conditions everywhere, the robust good health of the consumer, easing U.S.-China trade tensions, and the likelihood most developed economies will deliver some fiscal stimulus. In this scenario, corporate earnings will likely increase, as should dividends and stock buybacks, pushing share prices higher.

This doesn’t mean we can proceed with blinders on and our seatbelts off. There are complicating factors facing investors and reasons to be cautious.

Reasons to be bullish

i.   The next recession still looks some ways off

The arrival of “tight money”, defined by prohibitively high interest rates simultaneous with a sharply reduced willingness of banks to lend, has preceded every U.S. recession but one since the 1930s. Money is not tight. Borrowing rates are very low and could go lower. While policy remains accommodative and is likely to remain supportive, both lenders and borrowers report credit is plentiful and easy to access.

ii.   The dominant consumer can sustain spending

The other tailwind for the economy is the robust good health of the consumer who shows no signs of running out of steam. The U.S. unemployment rate is sitting at a half-century low. In the U.S., high savings, house prices comfortably back near their pre-crisis peaks, as well as the tight unemployment picture have boosted confidence. The consumer continues to spend at a rate sufficient to offset any weakness from other sectors. In order for the U.S. to slip into recession something has to seriously dent the condition of the consumer. That something would be tax increases or tighter credit conditions, neither of which seem likely in the near or mid-term.

iii.   The market has displayed few signs of vulnerability

Consensus earnings estimates are now more reasonable and look likely to stabilize. Valuations in North America are not outlandish, while they are cheap in Europe and Japan. As broad market averages and indices have moved higher, so too have the majority of stocks. There has been little evidence of any divergence within the market, lending confidence to the idea that this market advance has further to go.

Reasons to be cautious

i.   The yield curve inverted

Since World War II, the yield curve has inverted 10 times, not counting the latest instance in August of this year. One nine of those occasions, a recession followed on average 14 months later. We’ve noted previously that the recent inversion was more a result of long-term yields collapsing that the rapid rise of short-term rates. This is an important distinction, signaling inversion was not a result of painful tightening of credit conditions. The yield curve has since de-inverted, yet remains a source of caution moving forward.

ii.   Recession probabilities are increasing

The shape of the yield curve is just one of six indicators we use to gauge the probability of the arrival of a U.S. recession. Four of the six are still giving the economy a “green light”. If more indicator pins were to topple in the coming months, our caution would intensify and defensive inclinations grow.

iii.   Slow growth makes for a challenging investment environment

Our estimate for U.S. GDP growth next year is 1.75%, and an occasional negative quarter inducing more frequent bouts of market volatility can’t be ruled out. The growth rates in Europe and Japan, if anything, are likely to be weaker, and we’re unlikely to get broad corporate guidance that will overcome the investor angst resulting from a slower growth environment.

Invested but not asleep

For 10 years investors have been well served by the idea that portfolios should maintain at least a full, target-weight exposure to equities as long as there was no U.S. recession in sight. We continue to be of that view.

A comprehensive report from our Global Insights team is available here.

A publication titled ‘The low rate puzzle’ from Thomas Garretson and Mikhial Pasic of our fixed income team provides an in depth view of the implications of the current low interest rate environment.

In addition, Eric Lascelles, chief economist for RBC Global Asset Management, discusses the impact of negative yields in the global bond markets in a Q&A format.