2020 Market Call
Day three back at the desk – time for a round up of what to expect in 2020.
- US Central Bank policy was the biggest issue in 2019 and still is the biggest issue – Last year’s stellar performance from the bond and equity market was driven by the US Federal Reserve’s dovish pivot point in late December 2018. If the markets are going to continue to perform this stance cannot change. The biggest risk for 2020 is more a hawkish monetary policy approach from the US. It is unlikely, but understand that the US central-bank’s willingness to do whatever the markets want is the core of the current bull market. It cannot change.
- Big stocks have to perform – The top five publicly-traded American companies now make up a record 18% share of the S&P 500’s capitalisation (see chart below). Apple Inc., Microsoft Corp., Alphabet Inc., Amazon.com Inc. and Facebook. This “Rock in a Sock” bias to large companies has developed since 2016 and is the natural consequence of technology which has allowed companies, not just in the US (it has happened for opther non US companies like Alibaba and Tencent), to rapidly establish global business and brand dominance that was previously impossible. Technology has facilitated a once-in-a-lifetime global brand land grab in the last few years and the winners have emerged. Whilst it creates a risk in a few big stocks it is unlikely to reverse. The big have been getting bigger but they are likely to continue to get bigger. I would be more retrospect about some of the ‘parasite’ companies that have grown rapidly by exploiting ‘real’ business (Food delivery, Travel sites).
- The small also get bigger – We have seen evidence of this global land grab on a smaller scale with stocks like Afterpay (APT) – there are others – XRO, ALU, APX, WTC. Whilst the value based investor is wagging their finger at the PE of stocks like APT (and all those other mid-cap Momentum stocks), it would be a crime if technology-based companies like this, faced with this once-in-a-lifetime window of opportunity to achieve first mover dominance in their technology niche didn’t reinvest every dollar they had in the venture and in so doing castrate published earnings. If equity investment for you is about growth not income, about building assets not bleeding them, and if you are prepared to strike a fair balance between risk and reward, then for an Australian investor starved of the big US opportunities, these domestic stocks have to stay on the watchlist, because it is not about the price earnings ratio today, it is about establishing a brand for tomorrow.
- International global economic sentiment is key to the markets – All the US market leading stocks mentioned above have significant international sales (see tables below). The biggest US stocks are relying on global economic health rather than simply the US market. In which case one of the biggest risks to the equity markets is a deterioration in global economic sentiment, because it will pull down the big end of the US market, the stocks that have been the foundation of the current bull market. But realistically, with the US FOMC’s easing bias, with Trump calling for lower rates, with both seemingly unperturbed by the legacy of QE, with China stimulating, with Europe prepared to do ‘whatever it takes’ to ensure financial stability and with no major Central Bank under any pressure or showing any willingness to unwind accommodation and “take the pain”, this global economic stability should continue. Here are the geographic revenue splits of the top five US companies – almost all of them are earning over half their revenue outside the US:
- Resources a trade..as always – Big resources stocks had a stellar year in 2019 courtesy of the tragic Vale dam disaster in January. The iron ore price popped and dropped doubling from $65 to $123 at one point. For the calendar year the iron ore price was up 32.27%. The oil price also had a stellar year up 35.4% (good for BHP). Most other commodity prices disappointed. The coal price fell 34%. Aluminium fell 6%. The zinc price fell 1% and the copper price was up 4%. Nickel stood out amongst the metals and was up 34%. The perpetual stance on resources is that this is a sector to be ‘long duration’ traded not blindly trusted. The iron ore price created a fabulous backdrop for BHP RIO and FMG last year, FMG was up almost 200%. This year, with the iron ore price peaking at $123 on almost exactly July 1 and falling to $93 over the last six months, earnings and dividends are understandably forecast to fall in the years ahead. Results from BHP, RIO and FMG in February (with production numbers this month) will deliver that “peak in earnings is behind us” message. We are fully weighted in BHP and RIO (no FMG ?) and are prepared to run with the bulls until persuaded otherwise. The trend is good but the fundamentals are unlikely to get any better and as you can see below, whilst the Chinese are likely to protect economic sentiment this year with constant stimulus, the GDP trend is continuing to slow. The chart below shows the Chinese GDP trend and the Fathom CMI indicator – a ‘real’ rather than official measure of GDP trend in China (there is a Chinese 4th Q GDP number on Friday). Happy to hold…until we’re not.
- Banks – I tire of writing about them – suffice it to say we are currently betting the selling and the ‘sentimental outrage’ post AUSTRAC has left them looking good value (again – they looked good value higher up as well and that was a mistake). We have fully weighted particularly in CBA ahead of CBA’s results early in February. There is some bottoming on the charts. A gradual evaporation of the negative sentiment is all income investors need. It will happen over time. If the sector can just stay under the radar this year it should deliver a respectable total return for income investors in 2020. This is not a sector for growth investors. You lot can move along.
SUMMARY – 2020 MARKET VIEW
To boil it down:
- Nothing changes just because it’s a new year.
- Whilst it makes great headlines and provides interesting reading to speculate on what could possibly happen this year the easiest prediction, the most sensible prediction, is that the current trends/themes remain.
- Current themes are ‘happy go lucky’ to bullish.
- We need the trade issue to remain benign this year. Seems possible. It may even be a positive with the phase one deal about to be signed. It looks OK for now, trade is moving into the background, but we all have to worry about a return in volaltility because of a change in this central sentiment.
- There is little obvious threat to the global economic outlook as the trade détente continues. Central banks globally remain accommodative. China is stimulating, Europe is ready to print again if needed and the US FOMC is not about to pivot on interest rates, provoke fear, inspire the wrath of Trump and kill the markets.
- The US earnings season is just starting and for the big US financials in particular strong financial markets in the last year mean good results. The results season is usually a positive and could kick the market up again this month.
- Trump wants the market hitting new all-time highs in November. He is on our side despite the intense irritation and volatility he causes investors.
- Whilst the US market looks vulnerable on price (overbought, record high, highest PE in 17 years) all those big stocks that have led the US market and put the PE there are still growing and are unlikely to make big mistakes.
- Domestically 25% of the market (the banks) is cheap, oversold and in a sentiment hole already.
- The mid-cap Momentum stocks will continue to attract attention – but only until a market correction starts – we pray for that…an opportunity to buy growth stocks on their lows not their highs.
- The resources sector is in uptrend and there is no need to doubt it until there is a reason to doubt it.
Basically the risks of a precipitous collapse which were around last year have gone for now, in particular the trade talk risk. Whilst trade relations could upset the markets again at a moment’s notice, the advice is to “go with the market” until there is a reason not to. As the quote goes “Bull markets climb a wall of worry”. We have certainly expressed a fair share of worry over the last year and made our over cautious mistakes, and whilst we are quite prepared to do it again if we see fit, for now we are back to being close to fully invested and are back to our knitting – focusing on picking and timing individual stocks again. We are assuming it will be business as usual in the stock market until it isn’t, and we have decided that, for now, we will give the market the benefit of the doubt and react when it goes wrong rather than predict something that hasn’t happened. Despite that, we, as you, remain ever vigilant and cautious.
- Hong Kong protests will continue to make a lot of headlines that will be ignored by the equity markets. Hong Kong is/was important as a catalyst that could derail trade relations between the US and China. If trade relations continue to progress Hong Kong continues to be a financial market irrelevance.
- If it goes bad it will be bad – JP Morgan say the US markets are vulnerable to a sharp reaction in the event of negative shocks – call option buying has overwhelmed put option buying in the last month to a level not seen in 20 years and the S&P 500 PE is at its highest level since 2002.
- Brexit – There are still some uncertainties, delays are inevitable, but at some point we are going to forget the issue and the UK will get back to business as usual. Exiting the EU, whilst messy, will establish a new era of UK opportunity and growth. This time next year we will look back and see Brexit as a fabulous opportunity to have bought British and in particular the British pound (GBP), at a discount. There are a few listed stocks in Australia that will benefit from a lift in the GBP and a lift in UK economic sentiment – notable stocks include JHG and VUK. There are others. Brexit caused that sharp drop in the pound in mid-2016. The market appears to have started to anticipate a Brexit resolution some time in August last year. If you want to buy anything in the UK, holiday there or shop in the UK on the Internet, you had probably better get on with it.