Channeling the Ghost of Christmas Future and Evaluating What’s in Store for 2020
“Reflect upon your present blessings—of which everyone has many—not on your past misfortunes, of which everyone has some.” – Charles Dickens
As we return from the Thanksgiving holiday and adjust our focus to December and the new year, it seems appropriate to read some Dickens…particularly so this year. As suggested in the quote above, we indeed have much to be thankful for when looking at 2019 market results. Contrary to the chorus of warnings of possible recession and associated doom and gloom for the stock market that appeared in the headlines this time last year, the S&P 500 has advanced over 25 percent this year1, and the expansion continues.
The result is pretty much as we expected. We thought stocks were a bargain when the price-to-earnings ratio of the S&P 500 fell to 14 times earnings2 on Christmas Eve 2018, and that sellers of equities at that time were jumping to conclusions of worst-case outcomes on all fronts…in essence chasing ghosts (such as a faux recession) that simply didn’t exist. With the highest conviction, we looked for robust double- digit returns this year and better than feared results and that’s just about what we got.
Now it’s time to move on from reflecting on the ghosts of Christmas past to examining the future. In today’s commentary, we maintain a positive message on this front. While we must always be conscious of potential risks and are aware that the landscape isn’t picture perfect, the general fact set and the continuing sober, skeptical mindset of investors, remains supportive for equities to hold their healthy gains in 2019 and to move higher in 2020. This movement may not be at the pace we expected and enjoyed in 2019, but, we believe, not unlike what we experience in an average profitable year in the markets. In our experience, by the way, so-called picture-perfect backdrops, during which investors have become unrealistically euphoric, generally seem to lead to well below desired results.
Overall, we continue to feel good about the U.S. equity market and are not overly surprised we maneuvered through the seasonally-tough three-month “Amen Corner” period of August to October in fine shape. Now, seasonality tends to be a tailwind, as shown in the chart below.
*Chart from Strategas
November and December tend to be stronger months in the market than those in early fall. November 2019 is cooperating nicely with this tendency as stocks were up 3.6 percent for the month3, and November was the strongest month in the market this year since June…and that’s saying something considering that we experienced the strongest June in the market since the 1960s!4
Fundamentals remain supportive in that “moderating but still positive” zone. Valuation seems reasonable and not unattractive as advertised. And, the technical backdrop, with regard to sentiment and the broadening positive price trend in stocks, looks to be only getting more constructive. In terms of price targets overall, we are inclined to take our target for the S&P 500 up to the 3300+ level if we see anything but disaster on the trade and policy front.
In terms of positioning, we are staying with our call for a balance or a blend of growth and value equity exposure, rather than preaching extreme overweights in either the cyclical/value or more defensive/growth camps…like many seem to want to do. Furthermore, while we can talk about aggregate price level targets ad infinitum, we find attractive opportunities at the individual stock level and see a number of stocks in our opinion with healthy upside potential if recession indeed is avoided, as we expect. The continued attractiveness of stocks to us at the individual stock level is a key reason we remain constructive on equities overall. We still like domestic over international equities but are noting that international stocks are trending in positive fashion, and perhaps we can look forward to stabilization in the global economic backdrop and drivers of stock prices in foreign markets in 2020. We will cover all of this in more detail in our upcoming Crystal Ball forecast in January.
In addition to this general summary, the following are a couple of key observations or themes that we are highlighting at present:
- What Recession?
The fundamental data appears far from recessionary. The latest examples include the stellar October employment report with over 128,000 net new jobs created (despite a labor strike at General Motors), positive revisions for prior months and signs of greater participation in the labor force. Third quarter gross domestic product (GDP) came in at over 2 percent5 and Q4 GDP, which had been thought to be pacing at less than 1 percent so far, was recently revised up to expectations for closer to 2 percent growth.6 Housing and retail sales remain solid and demonstrate that consumers are spending. Black Friday sales this season were up over 15 percent this year to record levels (with online sales this day up 19 percent), and this despite the fact the consumer savings rate has surged from the 2 percent level to over 8 percent recently7.
None of this sounds recessionary to us! Didn’t some believe that inverted yield curve was supposed to assure immediate recession? Headlines flooded media with announcements of inversion of the yield curve earlier this year. Our take on this at the time: We noted that true inversion requires us to see a sustained negative yield curve slope. Interestingly, we’ve heard nothing but crickets in the media now that both the 3-month to 10-year and the 2-year to 10-year curves have un-inverted,8 and they are quickly, once again, positive in slope.
In addition, Q4 2019 provides a seemingly far better setup for 2020 than Q4 2018 did for 2019! Specifically, only a year ago, the Federal Reserve was suggesting they might hike rates and trade discussions were going off the rails. Fear was widespread that we were going to get worst-case outcomes on these policy fronts, and that this alone might cause recession and a train wreck in U.S. stocks. This was exacerbated by the tough comparisons on the earnings front. The 2018 S&P 500 earnings growth had been amplified by tax cuts; pundits pontificated that the high earnings bar set by heightened 2018 earnings figures would result in earnings DECLINES in 20199.
We felt differently and thought earnings growth would merely moderate rather than go negative, which is what indeed happened. This was also a primary reason the market proved resilient. Our right call on this is beside the point. The point is that, as we move through Q4 2019, the Fed is acting in very adult-like fashion. We are getting close to a “phase 1” deal on trade with China and earnings comparisons seem far more favorable when looking at 2020. These factors, we believe, are acting as tailwinds for the market as we close the year, rather than serving as the headwinds that they were at year end 2018, which caused that almost 20 percent swoon in December. This is not to say we couldn’t see a 5-10 percent correction in the market if we experience disappointment on any of the current policy or data fronts. We believe that, because the true underlying fact set is more favorable this year (as well as better than earlier feared and at a seemingly healthy level overall), this would present a buying opportunity.
- Balance is the Key in Positioning
There are many calls to take a more extreme approach as we increasingly hear about this rotation into cyclicals. Others disagree and think that after a 10-year-plus run in U.S. stocks, it’s time to be defensive, especially in a weakening global economic environment. Our take? The answer is yes! Rather than trying to be heroic and leaning significantly either way at this juncture, we suggest exposure to a nice blend of cyclical and defensive positions. What we see is a broadening in the market not a decided rotation solely into cyclicals. It is clear in our opinion that both growth and value are working right now, as can be seen by the new highs being achieved in both the Russell 1000 Growth and the Russell 1000 Value indices, as illustrated below. We feel this is not the time to invest all in one camp at the expense of the other. Bottom line, we think diversification and balanced inclusion of both is the way to go for now.
- Our Wash, Rinse, Repeat Theme Remains—Embrace the Wall of Worry
Going all the way back to the beginning of this recovery and certainly over the last year, there is this tendency for negative headlines or Wall of Worry items that are seemingly more emotional in nature to spur sell-offs in the market (wash cycle), which is quickly followed by the release of positive fundamental data (e.g., recent employment report and retail sales data) and the market surges and advances to higher highs (rinse cycle). Wash, rinse, repeat—the lesson from this is that, at the end of the day, it’s the data not the headlines that tend to prevail.
Impeachment and politics seem to be the new wall of worry headlines. Previous moments on the impeachment front, such as with the Nixon and Clinton eras, show that the economic and earnings data usually trump the politics…in other words, so goes the economy, so goes the market in these earlier periods. We think this center of gravity remains the same.
As for angst over the upcoming campaign, we all know there will likely be drama to come. Only if there are extreme results, such as a one-party shift in all chambers, as an example, does this truly result in massive policy shifts. Massive policy shifts tend to be what unsettles the markets. In recent weeks, we’ve seen more moderate candidates surface, and it is moderation and contained uncertainty in policy that the markets tend to embrace, regardless of what party controls the White House. More to come on this, of course, but we think it’s way too early to make investment decisions based on likely outcomes. For now, we say, economic and earnings trends rule…and likely so in the wash, rinse, repeat style!
For us, we see the expansion and more modest but positive gains in 2020. We would like to see a more balanced economy going forward (and companies begin to invest and purchase plant and equipment for their businesses in a bigger way next year) rather than the U.S. consumer having to carry the burden. Stabilization in global markets, de-escalation on the tariff/trade front and potential closure on the Boeing fiasco alone should aid 2020 on this capital expenditure front, but for now we feel the U.S. consumer is getting the job done in acceptable fashion. More to come on this in our Crystal Ball next month. Happy holidays and thank you for the privilege of serving you in 2019!
4Barron’s “Small stocks large hopes” by Randall Forsyth (Dec. 2, 2019. Page 7)
6Wall Street Journal “Economic Data Brings Cheer for Holidays” (Nov. 29, 2019, Page A2)
8United States Treasury Yield Curve
The S&P 500 Index is a market-value weighted index provided by Standard & Poor’s and is comprised of 500 companies chosen for market size and industry group representation. The Russell 1000 Value Index is the largest 1,000 value stocks by market capitalization. Value is determined by Book-to-Price ratio (B/P). The Russell 1000 Growth Index is the largest 1,000 growth stocks by market capitalization. Growth is determined by the I/B/E/S earnings growth rate two-year forecast and sales-per-share five-year historical sales. Investors cannot invest directly in an index.
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