Vanguard Group Inc. Chief Investment Strategist Joseph Davis thinks investors are being way too optimistic in the stock market as 2019 wraps up, and he sees a big risk for a sell-off happening in 2020.
Davis also holds the title of chief economist at Vanguard, and he argues the likelihood of a U.S. economic resurgence is lower than investors think. He puts the risk of a market correction at 50% in 2020, which is much higher than what he calls the typical 30% chance.
“Financial markets run the risk of getting ahead of themselves,” Davis said, according to Bloomberg.
Corrections are seen as any dip in the market of 10% or greater. The S&P 500 hasn’t experienced one since December 2018, which came dangerously close to 20% (aka a bear market), but it did weather some drastic drops this summer amid trade tensions between the U.S. and China.
While 2019 was the year of fear, with many warning of an incoming recession based on uncertainties surrounding the U.S.-China trade war, Davis thinks investors will be too optimistic in 2020. And he warns of increased volatility in the equity market, which he thinks is at “unsustainably low” levels.
“Across the board, expected returns for most strategies are below trailing three-year returns,” Davis said. He estimates that risk assets are assuming U.S. economic growth will be close to 3% over the next year, which he calls unlikely.
Bank of America sees the potential for a “risk asset melt-up” happening in the first quarter of 2020, but it doesn’t think it will last throughout the year.
One reason Davis sees an impending slowdown is because equities in the U.S. are getting too expensive. Vanguard prefers to use price-to-earnings ratios when evaluating markets, and it thinks the prices are on the expensive side of fair value.
As far as where Davis sees value, he thinks active investors should look to value stocks. Also, mortgages are looking “a little more attractive than they have for some time.” But he thinks it’s a good idea to hold off for now because “there will be better entry points” later in 2020.
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