Down the Pike
Review, Preview, History, Politics & Opinions Part 2 of 5
“Do not dwell in the past, do not dream about the future, concentrate the mind on the current moment,” a famous Buddha quote. I can tell from that quote alone, he never managed money for a living!
Forecasting is a fool’s errand for portfolio managers, however that will not stop us from trying, nor should it. History can teach us, mistakes can beat us, getting it right will swell us, but reversion to the mean will inevitably be us. That’s my motto and I’m sticking to it… I say this as for the first time in a long time…I’m more hawkish than most of the commentators out there. Meaning I don’t think we will see the returns that most feel we may get in 2020. Although I still believe we are still in a bull market and will be for years to come.
Let’s first look at history and what it can teach us.
Now if we hang on to the 2019 gains, the math looks good to attain positive returns in 2020. The average return of the S&P 500 following a 20% year is 11.1%, and the year after a 20%+ return has been positive 70% of the time.
Source: Factset, MGA
Now talking politically, 2020 is an election year and fear is heightened about the outcome. What the markets tell us is that 82.6% of the time the market is up in an election year and the average return again is 11.1%. (Now that’s freaky).
Source: Factset, MGA
Mistakes that Beat Us and the Wins that Swell Us
There’s one certain thing I can tell you about the markets in 2020: They’ll either be up, down, or flat. Anyone who tells you otherwise is either trying to sell you something, fudging the numbers (how ya doin’ Madoff?), or has never been on the wrong side of a losing argument (and there aint many of them left in the financial industry). Most investors still remember the market demise from the tech crash and subsequent financial crisis. Looking back at both of those times, I can tell you I made mistakes in both time periods, that in hindsight, were avoidable. Thankfully none of them were to the point that they were deadly, however I went against the common principles that I invest by today. Those two things were 1) going outside of your process and 2) not maintaining your discipline.
Today, my priority is the management of risk rather than the management of assets. There are principles of risk that are time tested and going outside these can get you to a point where your exposure is greater than it should be. Exposure doesn’t necessarily always mean greater risk; it sometimes means not enough risk. Either way, drifting outside those parameters puts you in a position where you’ll get it right, sometimes really right, or wrong, and sometimes really, really wrong. If I get it wrong, I want it to be for the shortest period of time, with the minimal impact, and I never want to be in the position to get it really, really wrong.
Overconfidence is the catalyst to bad decision making, and a swelled head. A few wins can sometimes be the jabs that you receive just prior to the knockout punch. This “recent” market has certainly felt like that to me. As I’m watching most analysts and forecasters lift their 2020-year end targets, by lifting the multiple rather than lifting their earnings estimates, I can’t help but feel that it’s setting up for a combination. Remember the term “multiples” refers to the amount of times you pay of earnings to own the S&P 500.
When analysts are consistently raising their multiples, I believe sometimes they are chasing the market higher rather than looking at the fundamentals. For instance, not many people had the year end target for the S&P 500 at 3160 (which is where it is at the time of writing), so you are seeing a bunch of upgrades now. Most are still calling for around a 6% earnings growth for 2020 but are lifting their multiple up closer to 20 times earnings to get their 2020-year end targets. They argue that the path ahead with the Fed, and newly negotiated trade deals is the justifier. They may well be right, although they are now exposing themselves above the average multiple. The simple graph below provides a visual display.
Source: MG&A
Reversion to the Mean
As I wrote in a previous article a big part of my investment philosophy revolves around reversion to the mean. Click here to read. Meaning things will ultimately come back to the average. I guess it’s my way of not getting caught naked when the tide goes out as Warren Buffett so aptly put it.
Let’s put some numbers around it. I have the 2020-year-end target at 3287, being $173 per share of earnings with a 19 multiple on it, which is around a 4% move from here. Doesn’t sound that exciting till you take into account that if the market feels it’s clear sailing ahead, with a negotiated trade deal and no monetary surprises from the Fed you could see the multiple be 10% higher, which would take it up to 21. That would have the S&P at 3615 without an EPS increase and give the index a 17% rise from here.
Digging Deeper
Even though I believe the market may not give stellar returns in 2020, it does not mean there is not opportunity underneath. Breaking down the sectors provides some interesting data points. Tech was the best performer in 2019 so far and I believe that will continue into 2020. Last week I highlighted some concentration among the top 10 names in the overall market and how much that has contributed to the returns this year. Although I think the Tech sector overall will be strong, I believe there will be a shift away from the big 10 and some of the smaller names may catch up. Overall, the sector is predicted to grow earnings around 10% next year. It’s the sector with the highest level of cash on balance sheet, which provides opportunities for increased dividends and/or buybacks. I also feel that there is a change in what will cause technology to continue its robust growth and that is 5G. 5G has the capacity to provide 20 GB bands (5 times faster than current) and requires an infrastructure build to reach its full capacity. This transition away from current platforms could be a decade long cycle, and we are only in the early innings. Potential revenue generated just for the services providers is predicted to hit 700 Billion in 10 years from now. The real benefit I feel however, will be to some of the smaller players in the tech industry whose stock price has not moved as much as the big players. 5G for them will be like the internet was to Amazon.
- My main take away with all of this, I believe:
- The bull market has many years left to run.
- Don’t chase forecasts based on current market moves.
- Stay with your process and discipline.
- Always look for value, and the next generational moves.
With that, Here’s the Buy Sell
Source: MG&A
Any opinions are those of Mick Graham and not necessarily those of RJFS or Raymond James. The information contained in this report does not purport to be a complete description of the securities, markets, or developments referred to in this material. There is no assurance any of the trends mentioned will continue or forecasts will occur. The information has been obtained from sources considered to be reliable, but Raymond James does not guarantee that the foregoing material is accurate or complete. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. Investing involves risk and you may incur a profit or loss regardless of strategy selected. The S&P 500 is an unmanaged index of 500 widely held stocks that's generally considered representative of the U.S. stock market. Inclusion of these indexes is for illustrative purposes only. Keep in mind that individuals cannot invest directly in any index, and index performance does not include transaction costs or other fees, which will affect actual investment performance. Individual investor's results will vary. Past performance does not guarantee future results. The companies engaged in the communications and technology industries are subject to fierce competition and their products and services may be subject to rapid obsolescence. Sector investments are companies engaged in business related to a specific sector. There are additional risks associated with investing in an individual sector, including limited diversification.
