You Know What They Say About Opinions
Review, Preview, History, Politics & Opinions
As I sat down to write part 4 of this series, I realized my thoughts on politics were echoing an email I recently wrote. If you’d like to re-read it, please click here. I’ll also touch on politics in this week’s article, making this the final installment in the series. They say opinions are like a**holes…everybody has one. However, being in the business of managing money, you should have one, and you should share those opinions to the people that pay you. In essence…if I’m executing on the ideas that I have, shouldn’t I at least tell you what those are?
Unfortunately, this is not the norm in the financial industry with too many people diverting the answers away from their thoughts, towards general overviews, or using language that is only understood by Industry Professionals. I don’t necessarily put the blame solely with my fellow Advisors, although there is plenty to go around for them, financial regulations, and Brokerage Firms Internal Compliance departments are the main culprits. These companies with their huge balance sheets, are easy targets for lawsuits, so they restrict the content that their Advisors can deliver. I earned my chops at a large Brokerage House and learned very quickly that putting things on paper, gives someone the ability to show you that you were wrong. So, tell them over the phone, don’t put it in writing.
That’s not how I’m built. I’m happy to give you my opinions, sometimes I’ll be right, sometimes I’ll be wrong…either way, I’m happy to take responsibility for what I believe at the time I believe it!!
So, let’s look forward to 2020 and beyond, for the markets, economy, and politics. Let’s start with the big picture, the economy. Both the global economy and the U.S. economy seems to be in a slow steady growth. This current expansion is now the longest in history, expanding now for 126 consecutive months. However, it’s been the slowest of the past 11 dating back over 100 years.
Source: JP Morgan
With the final revisions later this month on last year’s GDP growth, most economists believe the economy grew 2.1% in 2019, which is slightly lower than the 50-year average of 2.3%. The consumer who counts for around 70% of that figure is still strong, and in fact grew their net worth by around 10% last year, all the while lowering their debt service level as a percentage of disposable income. All this means that the main driver of the U.S. domestic consumption is in great shape, which should be a good indicator for the future.
Source: JP Morgan
Source: MGA, Factset, Raymond James
Expansions don’t die of old age. Something that we cannot foresee usually stops them. Yes, this expansion is the longest the U.S. economy has ever had, however if you look at the graph below you can see that other countries have had longer expansions, and three countries have had longer expansions in this expansion. Just because it’s the longest, doesn’t mean it can’t continue for much, much longer.
As much as the consumer is doing well, there are pockets of the macro environment that are worth paying some attention to. Historically, as you can see from the visual, recessions have the greatest chance of happening during the first year of a Presidential 4-year term. There are a couple of other charts that have historically shown the end of a cycle, including low employment and jobless claims, as well as a yield curve inversion, which we had last year. Historically the recession has started 22 months after a yield curve inversion, therefore if history was to repeat itself, that would land a recession starting early in 2021.
I’m not giving these indicators much credence; however, I want you to see them. I’m predicting another slow and steady growth pattern with the Fed sitting on their hands after some major bungles in 2018 and early 2019.
Source: MGA, FactSet, Raymond James
PolyTics
Let’s now turn our attention to the Presidential Election later this year. Although I will argue that it does not matter which party wins the election, ( see my earlier article on market returns under both parties), given that markets have had the highest volatility during the first year of a Presidential cycle, it’s worth paying attention to.
Below are some visuals that can give you an overall picture. The President’s overall approval rating is at a low point going into a re-election year, however his approval rating on the economy is very high. When you look at the President’s approval rating versus other institutions, you can get some perspective around it. The President’s approval is higher than the Supreme Court, the Church, the medical system, and of course, Congress.
Source: Predict Data
Source: Predict Data
Source: Factset
You can’t dismiss the math, however. Elections are won by winning the Electoral College Map, not the popular vote. In fact, 2 of the last 5 Presidents won the election without winning the popular vote. The electoral map as it looks in the polls as of today show that the President will need to move one state from the Democrats to win re-election. As it stands now in the closest contested states, the President would need to swing Michigan, Wisconsin, or Pennsylvania to maintain office. It’s still only early days and the Democrats are looking likely to go all the way to a convention to choose their nominee, something that hasn’t happen since the 1950s.
Source: Predict Data
Two extremely reliable data points also tell us that when unemployment is low, the incumbent is extremely hard to beat, and the most accurate data point on election prediction is that when the markets are up three months prior to the election, the incumbent has never lost. Totally irrelevant to what we are doing on a daily basis, but interesting none the less.
Source: Predict Data
Markets
2019 was a great year, and I know most of you are thinking that it can’t happen again this year. That thought is bullish in itself. The more pessimism there is in the market, the more room I believe it has to run. The data tells us the year after a 20%+ run there is a 70% chance the following year will be an up year.
*Win Rate refers to the number of positive years.
Let’s look a little at the 2019 year returns, which were led firstly by a recovery from the last quarter of 2018, which I firmly place the blame on the Fed Chair’s ridiculous comments that we were nowhere near normalized rates, meaning he had no intention of stopping raising rates. At that time a lot of the data points were trending lower, the yield curve was flattening to the point it was going to invert, and our Fed Chair rather than saying we will review the data as it comes in to make our decisions, basically told us that he would continue to raise rates with no end in sight. He back peddled from this pretty quickly and since has lowered rates a few times and is now on hold pending data. It was the 20% decline we didn’t need to have!! Anyway…..
2019 returns were in most part (92%) driven by multiple expansion, meaning the investor in 2019 was willing to pay more for a stock based on its earning than the year prior, again because the multiples became cheap after the fourth quarter of 2018.
Source: MGA
Source: Factset. Chart highlights Price of S&P 500 index and the P/E ratio concurrently.
On the surface you can look at these charts and say, “we are expensive compared to history”, and you’d be right. So, to get a year that looks like last year, we would need earnings to start to grow again. Good news here is that most estimates have 2020 as a return to earnings growth, to the extent of around 10%.
Source: *MGA predictions for 2020
I’ve written for a while that multiples should be higher for various reason ( see article here), however trade tensions held me back from forecasting it. As it appears now, we are on a path to reducing some economic barriers. I’m comfortable lifting the multiple to where my predictive sheet shows, which is right around 19 times. That increases my year end for 2020 to 3309, and I have now put a number on year end 2021 at 3553. I will not change 2019, as I will own my pessimism for last year.
That said, your observation could easily be, “that’s not much upside from here”, and I agree with you…regarding the U.S. Large Cap companies that is. What’s starting to really appeal to me, are smaller cap companies who did not contribute to 2019’s returns in any meaningful way. All the major indexes, including the S&P 500, Nasdaq etc., all broke out on a technical basis, however small caps did not, and have only just broken through their technical trend line.
Source: FactSet
This could be for a number of reasons, however I believe that they were relatively unloved due to their debt level being higher than the large caps, and there was uncertainty on where rates were going so there was a fear that the cost of servicing their debt could affect their profit. With the Fed on hold, and the yield curve normalizing this does not appear to be as big of a concern.
Source: Factset
Internationally I see opportunity. The U.S. dollar has stopped its continual climb higher, and manufacturing overseas is starting to see some positive signs. That can be said for both Developed International markets as well as Emerging International Markets. The U.S. markets have dominated the globe in both economic data as well as market returns for a long time now, and I feel that reversion to the mean may be ready to change. Good news here is if that is to happen it will take a long time, so there is no need to rush in to try and get it. You can sit back and see if the theory is playing out before committing capital.
Source: JP Morgan
With that, here is the updated buy/sell.
Source: MGA
As always please feel free to reach out with any questions. Have a great week.
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