January 3, 2020
Making Cents of the Markets
Be in the Know
2019 was a great year for equity markets, as trade progress and central bank easing provided a tailwind to valuation multiples through the sluggish economic and earnings backdrop. The two day decline at the end of the year was just profit-taking as the tax consequences of selling those days was deferred for a whole year. Headwinds from trade have abated, as a phase one trade deal between the US and China is expected to be signed in DC on January 15th. After which, discussions on phase two are set to begin immediately. There will likely be hiccups through the path of negotiations in 2020, but we expect President Trump to do enough to support the economy and market into his 2020 re-election campaign, even if it means “kicking the can down the road” on the more difficult, structural issues between the two countries.
The tailwinds of central bank easing in 2019, along with dampened trade tensions, are likely to support improved global economic conditions in 2020. We view the consumer as on solid footing, and believe global manufacturing trends should improve in the year ahead. Earnings are also set to accelerate from muted growth in 2019 (albeit off tough year over year comparisons following tax reform in 2018). Expectations are for 5.5% S&P 500 earnings growth which is likely considering the strong holiday season and the outperformance trend of the last few earnings seasons.
Trade progress, low inflation, low interest rates, potential for global manufacturing improvement, and earnings acceleration all support higher valuation multiples. However, while the current S&P 500 P/E of 19.9x is not euphoric, it is above analyst expectations of 19.25x. Therefore, we view the current valuation as neutral and believe forward market returns will need to come from earnings growth at this point – which as stated, we expect in the 5-6% region. Any pullback in markets would be looked at as an opportunity for an entry point for additional cash but we’ll make that decision based on data and news at that time.
Prior to the Iran news, global stocks, including U.S. equities, started 2020 with more gains after China announced a new stimulus measure for its economy. Specifically, the People’s Bank of China said it will cut its reserve requirement ratio by 50 basis points on Jan. 6 and signaled it will continue to implement favorable policy in 2020. Central bank easing was a huge contributor to last year’s record run, so Beijing starting the new year with more easing has investors in a cheerful mood. Of course, lingering U.S.-China trade optimism, strong U.S. consumption, and low interest rates also remain on the side of equities.
Is there a bright side to the market weakness from news overnight that a US drone strike in Iraq killed Iranian General Qassim Soleimani? It took all the focus off of the December ISM Manufacturing report which came in weaker than expected. At the headline level, economists were expecting the index to rebound from 48.1 up to 49.0, but instead of a bounce, we actually saw a decline to 47.2, which was the lowest level since June 2009. The report also showed that, unfortunately, the weak activity was accompanied by rising prices. We’re keeping a close eye on this as it is the fifth month of contraction and the trade war is certainly having an impact on the US as well as China and the world. As disappointing as this report was, central banks still have tools and ammunition to stimulate the economy and hopefully boost manufacturing.
2019 closed with one of our best years ever and we are happy that our strategy allowed us to remain defensive when risks were high, yet benefit well from rising markets in the second half of the year. We have maintained the asset, sector and geographic allocations as we anticipate the momentum to continue, although our active management strategy allows us to quickly get defensive if the tide changed in markets.
The S&P 500 is a little extended in the short term (about 8.5% above its 200 day moving average), and a pause or normal consolidation would be healthy for the index to digest the strong gains that ended 2019. That said, intermediate term momentum remains solid. We believe pullbacks are likely to be light and would look to accumulate more positions in outperforming sectors such as Technology, Communication Services, Health Care, Financials, and Industrials. We believe 2020 will prove to be another positive year but not as high as we saw last year. The 4th year in an election cycle historically has positive returns and with the Fed at our back, low interest rates and to higher earnings growth potential – we look forward to managing your portfolio through another “interesting” year!
Chart of the Week
Last year’s impressive run (10 of 12 months positive) saw a drawdown of just 6.84% which is well below the historic average of 16.3%. That said, combine it with the 20% correction of 2018 and you have a double digit average. We’ve pointed out before that 1-2 corrections of 5-10% each year is normal and this year should be no different so it’s important to have a strategy that allows you to capitalize on the rising markets but get defensive when needed so you keep your profits.
Beyond the Markets
Happy New Year everyone! With the holiday season slowly wrapping up, heaps of Vancouverites are taking down their decorations and stowing them away for next year. While many items can be reused, the festive fresh-cut Christmas trees will have to be disposed of (along with any leftover turkey stuffing). Thankfully, there are a large number of chipping events taking place this month to help you with that! For a small donation, charities all over the Lower Mainland will be accepting and recycling trees to make your holiday clean up a breeze! Click here to find the location closest to you.
Listen to our latest Making Cents of the Markets segment on CKNW. We dove into the markets, charitable giving, and budgeting during the holidays! Listen here.
Take a look here at our latest North Shore News article where we discuss how this is the time to ensure you take advantage of any tax-efficient decisions that need to be made before 2020!