- Deutsche Bank chief strategist Binky Chadha has been more bullish than anyone else on Wall Street this year, but he’s far more cautious about 2020 because he has doubts about earnings and economic growth.
- He’s telling investors to play defense because of increasing concerns about the health of the US economy, including job growth and consumer spending. He adds that it’s possible a US-China trade deal will come too late to stop a recession.
- Less than a year ago Chadha was counting on a US-China trade deal to help the S&P 500 to his target of 3,250, but now he says it’s possible that the trade deal could come too late to stop a recession.
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It’s been a good year for the US stock market. But it could’ve been so much better.
It’s possible that no one on Wall Street is more acutely aware of this than Binky Chadha, chief strategist for Deutsche Bank. He’s been the Street’s biggest bull in 2019, estimating that the S&P 500 would hit 3,250 by year-end.
But the trade war seems to have derailed that, with the benchmark currently sitting about 8% from his target. And Chadha says 2020 looks less promising.
“US and global growth are a lot weaker than they would have been. And that is the main reason for why we remain skeptical on prospects for next year,” he said in an exclusive interview with Business Insider.
Economic growth has been slowing, and Chadha doesn’t think it will improve much next year. He expects expansion of 5% or less in corporate earnings, and says the market is setting itself up for disappointment by pricing in a stronger recovery.
“US growth has been slowing for quite a while. It’s about 12, 13 months now. Global growth has been slowing for 18 months now,” he said. “In an environment when growth slows, typically multiples would fall, too.”
Chadha says his forecast for 2019 presumed the US and China would strike a deal to end their trade war in the first half of the year. With no end in sight to the trade conflict, he says he’s not betting on a substantial stock market rally until there’s a signed trade deal and confirmation that tensions won’t escalate somewhere else.
But, by then, the trade chaos may have dragged on for so long the global economy won’t bounce back. While he’s not predicting a recession, he says that’s one possible outcome.
“If it basically happens too late, then the nonlinear dynamics of recession kick in,” he said. “There is a cumulative impact for the uncertainty surrounding it and that also weighs.”
The US market has broadly outperformed the rest of the world during the trade dispute, and the widely accepted reason is that the US is holding up better than other regions in economic terms. Chadha doesn’t dispute that thesis and is slightly overweight US stocks for now, but says he’s more worried than most about the economy.
“I see us slowing very clearly,” he said. “The labor market is actually running dangerously close to what has historically been proved to be a stall speed for the US economy.”
He explains that private payroll growth has “fallen off a cliff over the last six months,” and is close to levels that indicate a recession is coming. Chadha also disputes the theory that consumer spending, the source of about 70% of US GDP, is doing fine. Instead, he says there are obvious signs that consumer spending is due to slow down.
“Consumer spending is very much tied to income growth,” he said. “If you look at employment in services, growth rates have fallen dramatically.”
How investors should respond
With all of those challenges in mind, it’s no wonder Chadha is telling investors to play defense — something he’s done successfully despite his recent bullish positioning.
Right now he’s recommends overweighting government bonds, saying that even though yields are low, prices are generally reasonable and they’re likely to rise in response to weakening economic data.
“Historically, the 10-year yield hasn’t bottomed until the Fed has basically stopped cutting the rates, and convinced the market that it’s basically stopped cutting rates,” he said. “I would argue it’s not going to be able to do that until growth bottoms and turns around.”
Investors could implement that recommendation with a short-term bond fund like the Vanguard Short-Term Treasury Index ETF.
While high yield bonds can deliver bigger returns, Chadha argues that they’re tightly tied to the economic cycle just like stocks, which means they won’t provide much diversification in a downturn. He’s also underweight stocks broadly, and advises betting on defensive stocks like bond proxies and avoiding cyclicals.
“Sector performance is going to be driven very closely with perceptions of macro growth and whether we get the turnaround in growth or not,” he said. “Long the defensive sectors, underweight the cyclical sectors, and then rotate as one gets comfortable with the view that growth is bottoming and turning around.”
One way to get exposure to that idea is the Invesco Defensive Equity ETF.
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