Market Outlook for 2020: Is this the year the bull market ends?
Happy New Year!
What a difference a year can make! A year ago, investors were licking their wounds following a sharp stock-market correction. The 2018 fourth-quarter decline featured a near -20% price drop in the S&P 500 Index that left most risk-oriented assets down for the year. Fast forward to the end of 2019 and it was a sharp reversal for risk assets.
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Looking back to 2019
Among commodities, crude oil prices made up for 2018's steep losses with a gain of 34.5% in 2019. All of the positive performance was achieved early in the year. From May on, crude oil became a victim of the U.S.-China tariff war and the general sluggishness in global economic growth. This a theme worth watching. Among other commodities, gold advanced 18.9% in 2019. It was also one of the better performers in 2018, dropping by less than all but one of the asset classes. For some the reason gold is glittering is the fact negative inflation-adjusted interest rates have dramatically cut the opportunity cost of holding gold as a hedge against financial assets since the global financial crisis.
Turning to the bond market, most of the asset class had a decent 2019. The Bloomberg Barclays U.S. Government/Credit Bond Index (total return) surged 19.6%. The Bloomberg Barclays U.S. Aggregate Bond Index (total return), which includes securities that are rated as investment-grade quality or better and have at least one year to maturity, gained 8.7%. Meanwhile, the riskier end of the bond-market spectrum-high-yield (ICE BofAML U.S. High Yield Constrained Index) and emerging-market debt (JP Morgan GBI Emerging Markets Global Diversified Index) posted total returns in the mid-teens.
Looking ahead to 2020
The U.S. economy could continue to slow in the near-term, perhaps posting a year-over-year gain of 1.5% or less before reaccelerating toward midyear. The main issue I fear in 2020 is investor reactions to the stock market may not be well correlated to the underlying economy. As seen in the past two years, changes in investor expectations can sometimes completely be unhinged from the general economy. Having said that, there may be some slow down in 2020 but I see it as not as a bear or bust, but growth at a sluggish pace. Goldman Sachs Asset Management recently reported expectations of 3.4% global growth in 2020. Overall I am positive on risk assets in 2020 given the healthy underpinnings of this economy and the U.S. consumer seems stronger than in years past.
Though it remains to be seen the impact of the coronavirus on the Chinese economy, if history is any guide, past health scares caused only short-term market disruptions here in the U.S., which viewed in hindsight led to market opportunities for long-term investors.
U.S. Consumer Debt is at Record Lows
US household debt relative to disposable personal income remains at all-time lows, as shown in the chart below. Since the financial crisis in 2008, households have significantly paid off debt, with their financial obligation ratio falling to the lowest level since the 1980's. Low interest rates and a healthy labor market have helped households’ capacity to service debt. In turn, I expect the strong consumer to continue to support a growing economy and companies who can benefit from consumer discretionary spending may benefit this year.
Source: Goldman Sachs Investment Strategy Group, Bloomberg, and GSAM.
Investment Trends and Opportunities to Watch in 2020
Value stocks should prevail this year. There has been a record disparity in valuation between growth and value stocks going on for 
several years now. The richer valuations in growth stocks may be a sign that slower returns are possible for this sector. I see more opportunity in dollar cost averaging into Value stocks. Energy stocks pose attractive valuations as well. More importantly, I think this a good year for active management. Many passive indexes hold inferior companies saddled with high debt, that may be a headwind going forward. I like active managers with attractive downside capture ratios, which is a fancy way of saying not as down as much as the broad market, on average - Figure 2. Indexes capture 100% of the downside, since they are always invested, but active management can be more nimble and possibly limit the draw-down.
| The Value of Active Management |
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| Figure 2 - A good active manager can help manage the downturn. Source: Morningstar.com |
Looking abroad, the lessening of trade tensions and improvement in China's economic growth should provide Europe with a moderate boost in 2020. Though it remains to be seen the impact of the coronavirus on the Chinese economy, if history is any guide, 
past health scares caused only short-term market disruptions here in the U.S., which viewed in hindsight led to market opportunities for long-term investors. European equities have badly lagged the U.S. stock market on a consistent basis since 2010, as a result, their price to earnings ratios are more attractive. The chart below shows there have been a number of foreign stocks outperforming U.S. stocks. The world is a big place, and investing internationally has helped in some years. Could this be one of those years international stocks outpace the U.S. market?
The U.S. Dollar
The U.S. dollar's strength reflects our robust U.S. economy and low Federal Reserve interest-rate increases. The dollar has climbed in value considerably - see the chart below. By some estimates the dollar is overvalued. This could be the year the U.S. dollar may reverse to the downside. If the dollar does weaken, this would be a tailwind for non-U.S. economies and financial markets.
Investing abroad, but managing the risk
If investing in international or emerging markets seems too risky, there are ways to gain exposure to these markets but potentially limit the downside. There are a number of "minimum volatility" international and emerging markets ETFs which use a formula to 
invest in foreign stocks that historically have shown a tighter range of returns, this provides upside potential but hopefully limits the losses as well. Also, investing abroad comes with currency risk. To help manage the effect a rising or falling dollar has on international investments, some foreign ETFs employ currency hedging strategies to mitigate the effect a country's currency has on the investment.
Is Cash King?
There is a also a strong contingency of investors hoarding cash. A recent survey sponsored in part by Kiplinger's of 850 U.S. investors over age 40 with at least $100,000 in investable assets reported holding 18% of their portfolios in cash. A survey reported in the Financial Times found individuals across the world are holding 27% of their investable assets in cash. Hoarding cash can come with a significant opportunity cost. For those concerned about market volatility, there are a number of approaches to take including tactical asset allocation or using special investment funds that can hedge or minimize the volatility. Personally, I think buying good quality stocks that are currently out of favor is an approach I favor this year. For fixed income investors who are okay with some principal fluctuation, consider a laddered municipal bond strategy which can generate tax-free income and provide more yield than cash.
What about the election?
What a time for politics. Brexit may subside this year, but things will heat up here on this side of the pond. Yes, it is an election year, which means it will be a long year for those who turn on the TV or subscribe to any of the major news outlets -- the political ads will ramp up. We should get a sense of which Democratic nominee will face Donald Trump in the coming U.S. Presidential election by March, when 25 states and Puerto Rico go to the polls; California and Texas, plus 12 other states, will hold their primary elections on Super Tuesday, March 3. Presidential politics remain, in my opinion the wild card for equities this year. Markets have been volatile under President Trump as trade talks wax and wane, but markets can be equally volatile if a newly elected Democratic President upsets the apple cart. The picture should get clearer as we near the spring.
Having said that, in the past, an election year has been good for equity markets, namely one year after the election. The volatility during the primaries is often followed by healthy returns, see the chart below:
Conclusion
All in all, I expect the U.S. and global economies to continue growing, but at a sluggish pace. This should keep inflation under control and encourage central banks to remain accommodative. Quantitative easing also should help keep fixed-income yields relatively steady even as government deficit spending picks up. Altogether, this scenario should be positive for consumers and ultimately the stock market. However, there are no guarantees, which is big reason to remain as diversified as possible.
For those squeamish about short-term market gyrations, there is an old adage when it comes to investing in the stock market, and that is the 'downs are temporary, but the gains are permanent.' We have been through many trying times as a nation, including world wars, global financial meltdowns, and various booms and busts. There will always be more difficult times ahead, but I have faith in the resiliency of our institutions, our country, and our stock market. Perhaps this final chart below sums up the resiliency of the stock market over time more than anything:
For more information or to discuss further, please feel free to email me at maloi@sfr1.com.
Sincerely,
Michael Aloi, CFP
