In absolute terms, 2019 was an excellent year with stocks, corporate bonds, gold and oil all up double digits. This contrasted sharply with 2018 when virtually every asset class declined as a result of a growth scare reminiscent of those in 2011 and 2015. Economic growth in the US indeed slowed but remained above 2%. As it turns out, the 2010s will be the first decade in US history without a recession and home to the longest bull market on record. Life in the political realm has remained more volatile. While Brexit and US trade deals appear on a path to resolution, President Trump faces an impeachment resolution and the coming election is sure to keep 2020 interesting. From here, the economy and the markets figure to grind higher, albeit the latter at a muted pace.
Like the Roaring 1920s, we see the coming decade marked by the mass adoption of new technologies (e.g. artificial intelligence) and great societal change, in this case a focus on the environment in what we have called the Decade of the Planet. We are also seeing signs of a shift in the prevailing investment regime to one that favors our value-oriented Private Market Value with a Catalyst TM approach. Regardless of the macro events unfolding, we remain committed to our process and methodology and are excited about the opportunities ahead of us.
Politics, Economics & The Market
Much as a blinding snowstorm can give way to a crystalline paradise, the tumult of late 2018 created a wonderland of bargains in the market. In retrospect it appears investors correctly anticipated an economic slowdown that manifested itself primarily in the industrial and materials sectors (key purchasing manager indices spent the last three quarters of 2019 in contraction) and flat corporate earnings in 2019. However, the markets, ever forward looking, rebounded as the so-called Powell and Trump puts were triggered. Federal Reserve Chairman Jerome Powell backtracked on his project to normalize interest rates, cutting rates three times and increasing bond purchases and overnight funding operations. After escalating trade hostilities with China, President Trump showed an increasing willingness to make amends, culminating in Phase One of a deal announced, but not signed, in December. All the while, the American consumer has remained steadfast, supported by the lowest unemployment rate (3.6%) since 1969 and rising household wealth (+3% to $114 trillion).
The 2019 manufacturing air pocket may be the pause that refreshes, extending the 126-month expansion, the longest on record. The strength, breadth and length of this expansion will clearly be influenced by a number of factors including the outcome of the 2020 presidential election and the many issues underpinning it – wealth inequality, educational and health care costs, trade policy and the national debt/deficit (we would prefer a bit more focus on the latter).
With a recession postponed yet again and interest rates lower, the total return of the S&P 500 exceeded 30% in 2019, propelled almost entirely by an expansion of the average earnings multiple from 15x to 19x. Earnings in 2020 should benefit from accelerating economic activity and an easier comparison versus 2019. At first blush it may be difficult to believe multiples could expand or even remain flat from here, especially with the looming election, but considering that 2019 included Brexit, impeachment, trade crises and unrest in Hong Kong among other issues, it becomes less of leap of faith. Unforeseen events are sure to emerge in the new year, but the market is likely just as apt to continue treating them as noise.
The Great Rotation?
Equity returns in 2019 were by no means smooth. The market recovered its September 2018 highs in April and traded sideways until the late summer. The first nine months of 2019 followed the script of nine of the last ten years. That is, the most expensive stocks outperformed the cheapest stocks, or as popularly formulated, Growth beat Value. However, coinciding with the beginning of a year-end push higher, the second week of September saw an abrupt shift as some of the most adored stocks dramatically lagged the forgotten and forlorn stocks. Although Value ultimately lost again to Growth, it outperformed in fits and starts throughout the fourth quarter. Among the reasons: (a)
market anticipation of an economic upturn in mid-2020 benefitting cyclical stocks, which are more often also value stocks; (b) a steepening of the yield curve, particularly benefitting financial stocks which comprise more than one quarter of most value indices; and (c) a gap in valuations between dear and cheap approaching historical extremes.
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