Why Vanguard’s chief economist says there is an elevated risk of a ‘large drawdown’ in stocks

The narrative in markets these days is pretty simple.

The global economy has faltered, but has plateaued and will get better next year, on a combination of an expected reduction in trade tariffs and the lagged impact of interest-rate cuts. As a result, stocks keep grinding higher and notching records—on Monday, the S&P 500 SPX, -0.05% registered its 23rd such peak of 2019.

Joe Davis, the global chief economist and head of investment strategy at fund giant Vanguard, isn’t buying it. “In the year ahead, we don’t foresee a significant reversal of the [U.S.-China] trade tensions that have occurred so far. And with continued geopolitical uncertainty and unpredictable policy-making becoming the new normal, we expect that these influences will weigh negatively on demand in 2020 and on supply in the long run,” he tells clients. Davis says U.S. growth will decelerate to about 1% next year, and China also will grow below trend.

No surprise, then, that Davis isn’t terribly optimistic about financial markets, citing heightened policy uncertainties, late-cycle risks and stretched valuations. “Our near-term outlook for global equity markets remains guarded, and the chance of a large drawdown for equities and other high-beta [more volatile] assets remains elevated and significantly higher than it would be in a normal market environment,” Davis says in the call of the day.

High-quality fixed-income assets “remain a key diversifier.”

Returns over the next decade should be “modest,” with U.S. stocks expected to return 3.5% to 5.5% per year over the next decade. Global equities should do better—6.5% to 8.5% per year, for U.S.-based investors—because of both more reasonable valuations and the expected depreciation of the dollar DXY, +0.02%.

The buzz

Any news about the U.S.-China trade deal will inevitably drive sentiment one way or the other. The Senate is likely to pass a bill that would require the secretary of state to certify every year that Hong Kong retains enough autonomy to warrant special U.S. trading status.

There is a flurry of retail-sector earnings this week, and the early returns weren’t good. Home Depot HD, -5.45%  the world’s largest home-improvement retailer, lowered its sales expectations for the year, results that may cast a shadow over rival Lowe’s LOW, -1.23% as well. Department-store chain Kohl’s KSS, -18.17% cut its profit forecast. TJX TJX, +1.04% however beat expectations.

Medicines Co. MDCO, +18.81% rose in premarket trade as Bloomberg News reported the maker of cholesterol drugs may get a takeover bid from Novartis NVS, -0.14%. At the Dubai air show, a Kazakhstan carrier signed a letter of intent to buy 30 737 Max jets from Boeing BA, +0.52%, and the Wall Street Journal reported that 20 more planes were ordered by an unspecified buyer.

U.S. President Donald Trump’s impeachment inquiry continues, as Lt. Col. Alexander Vindman, an army officer at the National Security Council, and Jennifer Williams, his counterpart at Vice President Mike Pence’s office, are due to testify.

Housing starts data for October was nearly in line with forecast. New York Fed President John Williams will speak at a capital markets conference.

The markets

U.S. stock futures ES00, -0.06%YM00, -0.20% pointed to a stronger start, though the Home Depot miss took them off their highest levels of the session. Read Market Snapshot.

Gold GC00, -0.09% and oil CL.1, -1.75% futures edged lower, while European stocks SXXP, +0.05%  were mostly stronger.

The chart

Mark Zandi, the chief economist at Moody’s Analytics, has been warning over the risk of a global recession for some time. In a presentation, he showed a slide illustrating both the possible triggers of a recession and the economic impact those triggers would engender. Safe to say that a trade-war escalation and a no-deal Brexit worries Zandi.

Random reads

South Dakota has commissioned a public service campaign with the somewhat puzzling tagline “Meth. We’re on it.”

Twitter on Monday night debated an important topic: Did a Congressman pass wind on live TV? (He says no.)

Not a Nativity scene—a camel, cow and donkey were spotted roaming together, in Kansas.

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