By David Nelson, CFA CMT
After a very strong 2019 and 2020 just around the corner investors want to know if there’s enough fuel for the next leg of the journey. At the tail end of last year investor fear was fueled by a Fed seemingly on automatic pilot determined to normalize rates regardless of the economic consequences. It’s not surprising coming into the start of 2019 few including yours truly were looking for strong returns across multiple asset classes. Along with U.S. stocks, bonds, gold, Europe and even China shares have put in a respectable year.
2020 – Asset Class Performance
If current estimates hold calendar year 2019 earnings will be fractionally higher than last year as multiple expansion became the driving force behind equity performance. It’s true that there are any number of individual companies that have been able to grow the top and bottom line but for the broad market flat became the new up.
Focus shifts to 2020
In hindsight it’s easy to see the catalyst for this year’s record run. Without question the elephant in this room is the Federal Reserve and Mr. Powell’s decision to reverse course. Recognizing the last 3 hikes of 2018 were a policy mistake Jay and company reversed course first in rhetoric followed by 3 back to back rate cuts to undo the damage. The inverted yield curve that terrified markets early in the year is steepening helping to explain the improved performance of financial shares.
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With the Fed at their back investors shifted their focus to Washington and the on again off again trade talks. A year ago, a negative tweet from the President or press release from Beijing would send markets into a tailspin lasting weeks. Today reactions are muted with selloffs sometimes measured in hours. Recent stock performance has looked more like a market coming out of a recession, not the doomsday outcome fueled by the media for most of the year.
Before we get too comfortable and start to believe our own rhetoric let’s explore some of the challenges that lie ahead.
The biggest danger for investors is to extrapolate forward previous returns and sentiment. We all know that can change in a heartbeat with the biggest danger likely something we haven’t seen yet.
2019 was a gift
2019 was a gift from the Federal Reserve who have largely done their job and have few tools left to repair the bus if it breaks down. Many investors cite the ongoing trade talks with China and the potential of a phase 1 trade deal failing to materialize as a source of concern. We’ve been down this road before and know all too well that China will remain an adversary in every sense for years to come validating those fears.
We’ve watched all year as estimates came down every month followed by PMI data that still is under 50 showing contraction in manufacturing in large part driven by the uncertainty of a trade dynamic between the two largest economies on the planet. Multiple expansion can drive performance but not indefinitely.
Yes, all these items are enough to stop any market dead in its tracks but for the time being investors are looking beyond these challenges seemingly confident growth will return.
Without question the biggest risk we face despite all the above is rising rates. Asset classes compete for your dollars and with large cap stocks yielding just about what you can get from a 10-year Treasury equity investors are being paid to wait. Any return to a 3% 10-year yield without earning’s estimates moving higher will be met with the same ferocious 4th quarter selling we saw last year.
The good news is it’s something we can track day to day and for now a 3% 10 year is a distant memory.
So how do I take all the above and wrap it up into a tidy package that gives you an estimate of what 2020 will look like. The truth is we can’t. Some say they can and of course that sells books and newspapers but in the end the range of unknowns is too wide driven by personalities that defy prediction, not to mention every corner of the planet has its own dynamic that could change the shape of global markets at any moment.
We take the information available and make decisions day by day. The only bad decision is not making one.
The week ahead
While earning’s are all but done the first week of December has a lot of economic data to digest. On Monday we get the all-important ISM Manufacturing Index a source of concern for the last few releases. Any deterioration here could tell us the manufacturing sector is worse than we think. Estimate is just under 50 with anything over a sign of improvement. On Wednesday we get ISM Non-Manufacturing followed by Jobs Friday where consensus is looking for 190k print for non-farm payrolls. In the middle of all this data investors will still have to navigate a news cycle focused on China, impeachment proceedings in the House and rising tensions with North Korea.
I think we get the message. Back to work.
