Market MVP Award goes to…
By David Nelson, CFA CMT
There’s no other way to put it. 2019 was an extraordinary year some even calling it the GOAT. Sentiment heading into 2020 is a near polar opposite from this time last year. We kicked off 2019 adding to a Christmas eve rally but the sentiment was anything but jubilant. Coming on the heels of a vicious fourth quarter decline in 18′ any rally was viewed as a reversion to the mean or oversold bounce. The broadcast and print media became obsessed with recession pushing it from possible to probable to a near certainty.
To be fair an inverted yield curve helped play into those fears. It took 3 cuts (25 basis points each) to unwind the policy mistake from 2018. However, it wasn’t just monetary policy weighing on the market. The trade war with China forced PMI data below 50 indicating economic contraction in the manufacturing sector. A poor economic outlook with some of our largest trading partners like Germany and of course China added to the concern. Finally, with earnings growth closing out the year at under 2% it begs the question why such an impressive move for not just stocks but a broad array of asset classes. U.S. stocks weren’t the only asset class to deliver. International stocks, bonds and even safe-haven assets like Gold put in a strong performance.
Asset Class Performance 2019
In a vacuum stocks can’t continue to rise on just sentiment and multiple expansion. At some point investors remember what a stock certificate represents. It is your pro rata share of the earnings and or dividend stream of a company. But since nothing survives in a vacuum, we won’t try to either. The multiple expansion that drove this year’s markets must be looked at through the lens of an accommodative Fed that cast aside normalization and has now set a very high bar to return to hiking rates. Seeing inflation as still benign it will take clear overheating in the U.S. economy before they will walk down that path.
Market MVP award goes to…
While Jay Powell and the Fed deserve honorable mention and clearly a big part of the supporting cast that helped push 2019 to record highs, the MVP award goes to the U.S. consumer. In the face of it all the consumer never blinked confident in their future and willing to spend hard earned dollars that made its way into the economy. Driving that confidence was a strong employment backdrop and for some demographics record low unemployment. For the consumer to keep spending you need to have a job. This late in the cycle I would expect the monthly non-farm payroll numbers to level off and even decline. The canary in the coal mine will be the weekly unemployment figures we get every Thursday. Economists and strategists will look here for any sign of deterioration.
Jobs Jobs Jobs – Record Low Unemployment
Good News / Bad News
Let’s look at some of the good news as we head into 2020. While earnings estimates have continued to fall for most of the last year the pace of decline has started to slow and from a bottom’s up perspective, we’re looking at about 9% earnings growth. Not surprisingly most bulge bracket firms are coming up with mid to high single digit growth for the markets this year.
If signed on January 15 as the administration suggests we’ll have a phase 1 trade deal. Most of you know I’m skeptical of any deal with China but let’s look at the PMI data in March and April. With a few months of improving trade conditions the stage should be set for stronger data and in turn support the estimates for earnings growth
Most of my readers have heard the following before but it bears repeating. “Asset classes compete for your dollars” and with stocks yielding the same as a 10-year treasury you’re being paid to wait.
U.S. Yield Curve
Another sign of improvement is the yield curve. By June of last year, the yield curve was deeply inverted often a sign of economic contraction or a recession on the horizon. Today the spread between 2- and 10-year paper is 34 basis points and the yield curve has started to steepen. Not only a good sign for the economy but a clear benefit to the financial sector.
What to watch in 2020
Rates still top the list. If the economy does start to pick up, I would expect yields on the long end of the curve to rise. It’s imperative that earnings rise right along with them. We can’t expect another year of multiple expansion to drive markets. If rates on the 10-year rise above 3% without earnings coming along for the ride asset allocators will go back to their 2018 play book pulling money out of stocks and into fixed income. It’s the same as I stated earlier. Asset classes compete for capital and at those levels traditional fixed income buyers like pension plans and insurance companies can fund future liabilities investing in high grade corporate bonds.
Before we get too giddy and fall into the trap of extrapolating forward past returns let’s look at a few harsh realities. Bad things for stocks usually start in the fixed income markets. Since late August the Fed balance sheet has ballooned from $3.76T to $4.17T. That’s over $100 Billion per month to shore up what they believe is a dysfunctional repo market. They say they haven’t returned to quantitative easing. Like it or not it’s QE.
Fed Balance Sheet
Another area of concern is the oil patch. While the U.S. has largely become energy self-sufficient the other side of the story is that many of the projects are yielding less than expected. With reserves coming up short banks are re-thinking the sector and eventually access to capital will become more difficult making the rollover of debt a concern. High yield markets will be the first place to feel the pain so need to be monitored.
2020 is of course an election year and like any other will be a driving factor in equity performance and volatility. None of the following is a political statement just a financial observation. Readers of my posts come from both sides of the political spectrum. Maybe more important than the final outcome will be the candidates themselves. If the nominations move toward a centrist than I would expect markets to follow earnings and the economic data in that order. If it moves further left and a socialist agenda or Medicare for all become focus topics volatility at least at the sector level will increase. Healthcare, energy and even large cap technology will see large swings in price performance.
All in we enter the year with a market balance sheet showing assets and liabilities evenly balanced. A strong consumer, accommodative Fed and for the moment an improving trade picture top the list of assets. On the other side of the ledger political uncertainty, uncompelling valuations and some early warning signs in fixed income.
Predictions are for fortune tellers and I won’t try to make one here. 2020 kicks off a new year and of course a new decade. We’ll process the information as it comes in real time and move accordingly.
Thanks to all of you for your support throughout 2019. I hope you have a very safe and profitable New Year.