January 15, 2020
By Sarah Swan
“We find it both nostalgic and fruitful to look back at the past decade because it can help us refine and adjust our perspective for the year (and decade) to come.”
Happy New Year, and Happy End of a Decade—and a pretty blow-out one at that. We find it both nostalgic and fruitful to look back at the past decade because it can help us refine and adjust our perspective for the year (and decade) to come. The 2010s were characterized by the longest bull run in history, which began in March of 2009 and is still going, into the start of 2020. That’s a 130-month-old bull market! The average bull market, historically, is only 53 months. How come this one has been so long?
There are lots of reasons, of course, and its rather abysmal starting place in 2009 following the “Lost Decade” for stocks is one of them (virtually the only place to go was up!). But accommodative monetary policy (and even some fiscal policy) and a responsive economy, the unbelievable growth of some technology companies (a number of which make up today’s largest companies in the world: Google, Amazon, Apple, Microsoft, and Facebook, which didn’t even go public until 2012!), and mostly slow, steady growth in stock prices helped this bull market get to where it is today, without a single bear market, or drop of 20% or more, in almost 11 years. To cap off the decade, 2019 saw the S&P 500 gain over 31% and hit new all-time highs.
This was amidst fears over an impending recession, an escalating trade war, economic and political troubles in Europe (and other international markets), and a Fed that adapted and balanced feeling optimistic about the state of the economy and being accommodative enough to keep investors from getting too spooked. The year was not without its bumps of volatility, but a strong end of year rally helped close the decade in an impressive way.
In looking ahead to 2020, it’s hard to remember the last time so many extraneous factors and underlying scenarios would converge in one calendar year. The two arguably largest issues of 2019, from a headlines and sentiment perspective, were the trade war and questions of recession. Heading into 2020, interestingly, neither issue has been completely dispelled and yet neither is as prominently worrisome as last year. But they’ve been joined by other factors we (and the world) will be keeping our eyes on: Iran, impeachment, and the US election, to name a few. While individually these issues aren’t the kind to typically derail economies, they are the exact type of events whose headlines will surely impact markets on a day-to-day basis in 2020.
2019’s trade war story is one we’re all too familiar with—it was essentially a cycle of President Trump and Chinese President Xi Jinping issuing retaliatory tariffs against each other, causing market turmoil and worry, followed by a proposed negotiation for x date in the future and ensuing optimism in the market. It’s finally become clear that the fears of a worst-case scenario trade war that controlled so much of 2019 have basically been taken off the table. While the issue is by no means resolved, we know that both parties are willing to work towards a solution, albeit in smaller, bite sized pieces such as the “Phase One” trade agreement. The deal that was signed on January 15 cancelled plans for new tariffs to be imposed and reduced by half September’s US tariffs on $120 billion Chinese goods. China also agreed to buy more US goods, particularly agricultural produce. This agreement is a small step in the right direction and has calmed investors’ minds, at least for now.
While it’s nearly impossible to predict a recession, most economic indicators would suggest that it’s not likely to be an issue for 2020, and we agree with that. It’s been months since the couple of slight inversions in the yield curve that we witnessed in 2019 (a historic indicator of impending recession). We feel good about the fact that there doesn’t appear to be a lot of excess optimism floating around—although volatility is at historic lows, investors seem to be keen on a sense of realism about the state of things. Interestingly, though, the economy still feels like it’s split into two camps—the consumer camp and the manufacturing camp, whereby the consumer camp is what is largely holding up the economy of late with solid employment numbers, wage growth, spending, and overall confidence and sentiment. Manufacturing (which is more economically sensitive and therefore seen as a bellwether for the rest of the economy), as measured by the ISM Manufacturing PMI, has been showing signs of weakness for several months. The index fell to 47.2 in December, the lowest level since June 2009, and the fifth straight month of declines. Index readings below 50 indicate contraction; whereas readings above 50 indicate expansion. Trade is the main (although not sole) culprit, so hopefully the “Phase One” deal and continued progress on that front helps to improve manufacturing sectors. Globally, we are seeing some PMIs bottom, so we are hopeful for an inversion and improvement going forward.
In thinking about how the upcoming US presidential election will impact the markets, we need to consider how the months leading up to the election will impact them, and how the election results will impact them. The months before an election are impacted by one thing: uncertainty. We know markets don’t like uncertainty of any kind, so both common sense and history tell us that the closer an election (the more uncertainty about who will win), the more range-bound equity performance is in that year before: think mid-single digit returns. On the flip side, election years that aren’t close tend to see mid-double digit gains. In thinking about 2020, democratic nominee buzz alone won’t settle out until mid-March. And beyond that, we don’t think either party will secure a strong enough lead to take the closeness out of the race up to election day. Post-election, it is difficult to say how the results will impact the market and economy—it could mean much different things depending on the amount of surprise associated with the candidate’s victory and then of course the winner’s policy agenda.
Corporate earnings season has begun, and aside from all the other events and factors influencing the markets this year, earnings will likely play the biggest role. We see potential for earnings to grow in 2020, but probably skewed to the second half of the year, and limited growth, at that. Earnings have been strained for a few quarters now, so this is something we will watch very carefully.
Hopefully the lower rates and easy monetary policy from the Fed (which we see as staying fairly consistent for the foreseeable future) continue to flow through the economy and help to boost corporate profits without corporations having to cut costs via lay-offs and heavily reduced hiring—which would undoubtedly hit that stronger consumer side of the economy that we are so reliant on in this environment. Fortunately, this kind of balance sheet expansion and stimulus has been happening on a massive, global scale (not just by our central bank). Since there tends to be a lag in results from this type of stimulus, that would suggest that the positive impact will continue to flow through the overall economy.
As We Embark
With so many overvalued companies trading at high price-to-earnings ratios, stock picking will be paramount in 2020, making it a good year for active managers in theory. As 2019 wrapped up, we deployed some of the extra cash we’d been accumulating to get into names at fair prices and become more cash-neutral for the start of this year. Range-bound returns feels like a fitting theme for the year ahead. We believe underlying conditions are good enough that the rally can certainly continue—but due to valuations at the higher end of normal, we don’t think we’re very far from a limit. That is why we don’t see a minor correction as being out of the question, especially just to take some froth out of the market. Cautious optimism, which we’ve practiced many times before, shouldn’t steer us wrong as we watch the year unfold.