Hooray for the American ­consumer! Strong consumer spending has kept US economic growth and the bull market alive despite challenges ranging from trade wars and global economic weakness to political turmoil and a recently shrinking ­manufacturing sector. The ­consumer likely will continue to propel the economy and stock market through 2020 and perhaps into 2021, predicts renowned economist Allen Sinai. Because of the mounting threats, however, Sinai tells Bottom Line Personal that investors would be wise to temper their expectations for stock market returns and to expect much higher volatility as we head toward what may be the 12th year of an economic expansion and bull market. By late 2020, signs of a bear market could emerge, he says.

Here’s what Sinai sees ahead…

No Traditional Recession Triggers

Consumers are feeling happy and prosperous because the fundamentals affecting them are positive. Unemployment is at its lowest levels since the 1960s. Workers will continue to see slowly rising wages and a few extra dollars in their paychecks from the federal income tax cuts that took effect in 2018. And stock prices should remain high enough to bolster consumer sentiment. With consumer spending making up almost 70% of gross domestic product (GDP), it’s hard for me to see a recession in 2020 even though it’s long overdue based on historical patterns. Even more encouraging is the absence of the elements that triggered almost every recession since World War II. There are no signs of high inflation, little chance of rapidly rising interest rates and no evidence of financial excesses such as the 2007 housing and debt bubbles. And the Federal Reserve has been easing rather than tightening monetary policy—it was tight money that triggered eight of the 11 post–World War II downturns.

Some Atypical Threats

That doesn’t mean the news is all good. The economic expansion will continue to weaken in the face of some “atypical” drags on the economy that may not have affected consumers much but are hurting businesses in various ways. For example, growth in capital spending by businesses has slowed to just 2% in 2019, down from 6.9% in 2017. US manufacturing is probably already in recession and is among the few sectors losing jobs. The various threats could erode profits and lead companies to lay off workers. The resulting jump in unemployment could undermine ­consumer confidence and trigger an economic recession.

Here are the atypical threats that worry me the most…

Trade wars. US tariffs on imports from China and European nations were meant to force changes in policies harmful to the US. However, that strategy  could create so much uncertainty for US companies that they put off decisions to expand, hire and make long-term investments. My take: I expect trade tensions to ease, which could prevent a further decline in growth of capital spending.

Global economic slowdown. Major industrial nations, especially Germany and some other eurozone countries, have struggled in the past year, and so have China and emerging markets. This directly affects the stock market because so much of US corporate revenue comes from outside the country, including 43% of revenue for S&P 500 companies. My take: Global economic growth will remain unimpressive, but key overseas economies will avoid recession.  

Political turmoil surrounding impeachment and a presidential election. The Washington drama has CEOs and Wall Street especially nervous. My take: The 2020 election is the biggest unknown. Wall Street’s reaction will ­depend on the outcome and the effects on policies ranging from government regulations to taxes, trade and health care.

Key US Economic Measures

Here’s what I expect for the US…

GDP: This key measure of US ­economic activity will likely grow 2.5% in 2020 and just under 2% in 2021, compared with near 2.5% in 2019. Consumer spending should rise a very solid 2.7% in 2020 and 2.5% in 2021, on par with an estimated 2.7% in 2019. The likelihood of a recession in 2020 is 15%.

Inflation: As measured by the broad-based personal-consumption expenditures price index, inflation will continue to run below the Federal Reserve’s 2% target as long as there is not a steep rise in tariffs on imported goods from China and other countries. I expect the inflation rate to inch up to 1.8% for the 12 months ending in December 2020 ­versus about 1.7% for 2019.

Unemployment: The unemployment rate likely will end 2020 at 3.5%, slightly down from 3.6% in October 2019. In 2021, as economic growth slows, the unemployment rate will start to rise toward 4% but remain low by historical standards. 

Mortgage rates: Interest rates on 30-year fixed-rate mortgages will likely level out at 3.25% by the end of 2020, compared with 3.78% in October 2019.

Outlook for Stocks

The best of the bull market has passed. Including dividends, I expect the Dow Jones Industrial Average in 2020 to return 8%…and the S&P 500 to return 7%—much less than half what the indexes gained in 2019 through early November. Earnings of S&P 500 companies likely will rise 6%, similar to 2019 but down sharply from 23% in 2018.

By late 2020, big stock market pullbacks and signs of a bear market could emerge. Because of the threats ahead, investors should rebalance their portfolios to more conservative allocations by tapering overall exposure to stocks and shifting more toward the best stock sectors for this environment. 

Best stock sectors for 2020…

Health-care stocks are undervalued. The sector was held back in 2019 by ­opioid-related lawsuits, product-safety ­issues and proposed changes in health-care policy, including plans for drug-pricing regulations and various forms of Medicare for All. However, this remains the fastest expanding sector of the US economy, boosted by new technologies and growing demand from the rapidly aging US population. Health-care companies will be able to maintain earnings growth even as economic growth slows. Also, new legislation is unlikely before 2021, and any policy changes likely won’t be as drastic as some proposals have called for. 

Consumer-discretionary stocks will do well, especially in categories where consumer spending is the healthiest, including leisure, entertainment, restaurants and travel.

Stocks to avoid… 

Companies with inflated valuations in any sector will suffer. Skittish investors are likely to sour on stocks with very high price-to-earnings ratios (P/Es) relative to historical valuations—including some tech stocks—as signs of further weakness in the economy emerge.

The Bond Outlook 

The broad US bond market has defied expectations in 2019 with returns of 8.9% overall and 19% for long-term bonds, as of early November. But bond prices have appreciated so much that there is little room for further gains, considering how low interest rates are. I don’t expect the Federal Reserve to cut its benchmark interest rate further in 2020 after having cut it three times in 2019 through October. However, individual short-term bonds—with maturities of five years or less—that are held to maturity still can play an essential role in portfolios as shock absorbers during stock market pullbacks.