Richard Steffan of Barclays Isle of Man writes.

After a turbulent year that has seen financial markets trend modestly higher, what are the prospects for next year?

The outlook for 2020 can be summed up in two words: more uncertainty.

The economic cycle is getting older, a US presidential election is nearing, Brexit continues to linger and central bank heads (Bank of England and European Central Bank) are being replaced. So, after peaking at its highest level in more than 20 years in 2019, economic policy uncertainty is likely to rise further.

Economic policy is a vital parameter for investors: it sets the rules of the game. The level of taxation, the ease of doing business and the cost of borrowing are among factors that affect the value investors assign to a company, even though companies have no control over such factors. Economic policy has typically been relatively stable with only minor changes occurring over the years. But trade tensions, geopolitical sanctions, Brexit and unconventional monetary policy are changing those rules, or expectations of them, more than usual.

This not only affects investors, but also companies. It is increasingly difficult for companies to know where, and in which area, to invest. As highlighted in the third-quarter reporting season, companies gave little guidance to investors on their prospects blaming the ’rampant uncertainty’ as a reason for their relative silence.

Economic policy uncertainty also explains why growth in investments almost turned negative in 2019. Shifting rules make it almost impossible to take long-term decisions which is what investments entail. The trend seen this year looks set to continue, with consumption holding up economic growth while investment continues to be anaemic, except in certain areas such as technology.

With a recession still an outside chance but growth remaining lacklustre equities seem more attractive than fixed income investments, especially at this late stage of the economic cycle.

In both cases, returns are expected to be limited considering stretched valuations, low growth and increasing uncertainties. Equity selections are likely to be an even more powerful way to add value in 2020 than they have been this year.

In commodities, the additional uncertainty should strengthen the benefit of allocating to gold as a diversifier asset in a portfolio context.

In the oil market, supply should outpace demand, but the unpredictable geopolitical landscape is likely to keep the oil price in a range. Other alternative assets, such as private capital and uncorrelated hedge fund strategies, are likely to become even more valuable from a portfolio perspective.

With uncertainty on the rise investing in strategies with less short-term volatility and a focus on long-term fundamentals could be one way to add value.

Periods of heightened uncertainty create investment opportunities. For one, volatility is likely to surge periodically so investments that aim to profit at such times make sense. The systematic selling of volatility, via financial instruments known as options, is a strategy that should be among the main alternative strategies employed in a portfolio.

With uncertainty rising, the risk premia, or the compensation received from selling volatility, increases to compensate for the murkier outlook. There are also likely to be occasions when buying volatility can protect a portfolio when volatility levels dip, perhaps after a period of more optimistic news than expected by the market.

The biggest risk in 2020 is likely to come from an unexpected event rather than a severe economic downturn.

An event-driven sell off, as seen towards the end of 2018 as trade tensions mounted and the US Federal Reserve lifted interest rates, could trigger a market sell-off of 10% or more without the global economy going into recession.

On the positive side, a resolution of US-China trade tensions and, more broadly, market-friendly outcomes to geopolitical tensions could improve anticipated returns. Also, a more decisive fiscal stimulus in the world’s largest economies would improve global growth prospects more than currently expected.