In his famous book, "One Up on Wall Street," Peter Lynch discussed his philosophy of finding stocks that would deliver at least a 1,000 percent return, aka "ten-baggers." While his process involves identifying high-growth, under-covered companies, a macro-economy focused approach could also deliver stellar returns if the right industry can be identified at the right time.
In 2019, the information technology sector provided the best returns to investors whereas the energy sector performed the worst. Investors who were right about the prospects of tech stocks gained stellar returns.
Source: Data from Fidelity.
Overall, the S&P 500 Index has gained 28% this year so far, making 2019 a year to remember for many investors. As the year comes to an end, the focus is on identifying the winning themes of 2020. This could go a long way in determining the performance of investment portfolios in the year ahead.
Monetary policy boosts are unlikely in 2020
Company fundamentals are not the only factors that drive equity markets. For instance, in 2019, rate cuts by the Federal Reserve boosted investor confidence and played a role in the positive market performance.
Source: LPL Financial.
As illustrated above, the market performance after three consecutive 25 basis point cuts has been positive in each instance going back to 1975, and 2019 did not come as an exception. However, interest rates will likely remain unchanged in 2020. The below excerpt from the statement issued by the Federal Open Market Committee in December confirms this:
“The committee judges that the current stance of monetary policy is appropriate to support sustained expansion of economic activity, strong labor market conditions, and inflation near the Committee’s symmetric 2 percent objective.”
With the lack of a foreseeable change in monetary policy in the year ahead, investors should look for industries that would thrive under a low interest rate environment. Real estate, utilities and consumer non-discretionary companies could benefit from this development.
European equities look prime for growth
In the last five years, various geopolitical developments, including Brexit, prevented European equities from taking off (except for in France, where the CAC 40 Index gained 37% in this period).
Source: Yahoo Finance.
This underperformance of European markets relative to the S&P 500 Index has prompted many asset managers to search for investment opportunities in this region. Emmanuel Cau, head of European equity strategy at Barclays, wrote in his strategy report for 2020:
“For 2020, we believe that Europe and U.S. equities offer broadly similar upside, but we see the balance of risks around our constructive macro scenario consistent with a tactical preference for Europe vs. the U.S. We find current European equity valuations attractive compared to the U.S.”
There are multiple reasons to be bullish on this region. First, the majority of companies have continued to increase their capital investments in the last four years, and these will help earnings grow in 2020 and beyond.
Source: Schroders.
Second, consumer spending can be expected to remain strong in the year ahead as well, which is evident from the strong growth of eurozone wages in the last couple of years, according to data released by Thomson Reuters in December. This is a good sign for the economy and corporations in this region.
Third, European markets are much more attractive than their U.S. peers from a valuation perspective. The below graph plots the price-earnings ratio of a few major markets around the world.
Source: Reuters.
Even though Chinese markets are more attractive considering the growth opportunities and the current earnings multiple, European markets provide more value for money than the U.S. at present. Graham Secker, the chief European equity strategist at Morgan Stanley, commented in his strategy report for 2020.
“After 85 weeks of consecutive outflows totaling $150 billion, we have just started to see some inflows back into the region. We believe investor positioning is still significantly underweight.”
These inflows paint a positive picture of the prospects for 2020 and the iShares Core MSCI Europe ETF (IEUR, Financial) provides American investors with easy access to these markets.
Emerging markets provide value for money
Many analysts and economists agree that developing market equities will provide attractive returns in 2020 and beyond, although these regions have underperformed developed markets in the last five years. Morgan Stanley upgraded emerging market equities from underweight to equal weight on Dec. 13 and released a report in which they forecast strong growth in these markets in 2020.
Source: Morgan Stanley
The improving trade situation between the U.S. and China will provide a much-needed boost to equities in the Asia-Pacific region as well. Goldman Sachs shares this view. and in its report outlining the best investments for 2020, the company recommended going overweight on emerging markets:
“The good news is that this cumulative easing in domestic financial conditions, continued low oil prices, and a better external growth picture in the US and Euro area in the year ahead, should allow EM growth to bounce up off the mat, especially if we see a more stable period in U.S.-China trade tensions.”
GuruFocus projections for expected market returns in various regions of the world point to this same conclusion.
Source: GuruFocus
The MSCI Emerging Markets ETF (EEM, Financial) is a good way for investors to gain exposure to these markets.
Value investing is set to outperform growth investing
In the last 10 years, growth strategies outperformed value stocks by a healthy margin, leading to speculation whether value investing is no longer as effective as it used to be a few decades back. The below chart plots the performance of these two techniques as of Sept. 30.
Even though value has outperformed growth since 1979, in the last decade, the tables have turned. However, this development has pushed high-growth companies into overvalued territory.
With the global economy expected to slow down in the next couple of years, undervalued stocks could make a significant comeback while companies that grew their earnings by double-digits could find it difficult to improve their numbers any further. The year 2020 could mark the beginning of a revival in value stocks, and Rob Arnott, chairman at Research Affiliates, agrees:
“We’ve seen more and more people give up on the idea of value investing, which we think is a little strange because we’re in the only major industry in the global macroeconomy where people hate bargains. Value has been battered down now for 12 years, most particularly from 2015 to 2019, so the last five years have been daunting. Value is cheap.”
Investors may want to consider Vanguard Value ETF (VTV, Financial) to gain exposure to large-cap companies that are trading at low price-book ratios.
Takeaway for investors
Fiscal 2019, one of the best years for U.S. market investors, is coming to an end. In 2020, investors might want to follow a few key themes to generate attractive returns. Focusing on company fundamentals is of utmost importance as we step into a year in which further interest rate cuts are not likely. The new year will likely be a rewarding one for investors who follow the right themes and avoid overvalued sectors.
Disclosure: I am long MSCI Emerging Markets Index.
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