This is the time of year when I am supposed to make predictions for markets for 2020, or, at least give an outlook. This has become quite difficult to do in recent times as markets no longer appear to be driven by corporate fundamentals or macroeconomics. Rather, markets have been moved by: 1) passive investment flows; 2) corporate stock buy-backs; 3) TINA (There Is No Alternative), especially for baby boomers looking for some interest or dividend income in this time of microscopic interest rates; 4) Presidential Tweets, and by 5) liquidity injections (money printing) by central banks, also called quantitative easing (QE). [Note: The liquidity provided by central banks has, indeed, resulted in inflation (in equities and real estate), just not the type that the monetary authorities desire (which is some inflation in the prices of goods and services).]
None of these five influences are driven by economic fundamentals. Rather, the first three are a function of Wall Street’s current narrative (always that stocks are cheap), and the last by what appears to be a new view of what central bankers are supposed to do (i.e., protect asset prices). My view of market value continues to be tied to what the macroeconomics and corporate fundamentals tell me, as I believe that, eventually, those will be reasserted in market prices.
The Santa Rally
Equity markets continued to rise in the U.S. Record highs were hit on all three major U.S. Indexes in late December. The consensus on Wall Street, or at least on the sell side, is that there won’t be a recession. Indeed, the belief is that the Fed acted in time, we are going to have a soft landing, that Q4 will be the low point, and that the economies of the U.S. and the rest of the world will reaccelerate in 2020.
Recent data supporting this view:
- The Mastercard report that retail grew by +3.4% (nominal) in the 11/1 to 12/24 period with in-store sales up +1.2% (nominal) and on-line up +18.8% (nominal). Note that in-store real sales are flat.
- U.S. Personal Spending rose +0.4% (Commerce Dept.) in November and Personal Income was up +0.5% for the month. Both were higher than consensus.
In the short-run, financial market will be very much influenced by U.S. consumer spending in the holiday period, as it is the consumer that has supported U.S. aggregate GDP growth, what little there is. A second short-run key for markets going forward will be the January 3rd employment report.
Uncertainties
On the other end of the spectrum, there remains a whole set of economic uncertainties that should not be ignored (but currently are):
- The Fed, with its QE4 ($500 billion) support of the financial markets, is another key to 2020. Ostensibly, the Fed is acting only over the year-end to make sure the repo markets don’t get out of hand, as there are seasonal pressures on rates at year’s end, albeit, $500 billion seems outlandishly large. So, if, indeed, their support of the repo market is only temporary, as they have indicated, then markets should watch-out when the music stops.
- Also, some of the world’s central banks have concluded that negative interest rates aren’t working to revitalize economic growth, and, as they move toward more normal policies, there will be less liquidity available for the financial markets. As a result, the worldwide total of negative yielding bonds has fallen from $18 trillion to $11 trillion over the past couple of months.
- Worldwide, China is in the midst of its slowest growth on record with growing issues in its debt markets and its banking system. India, the fastest growing economy, has slowed markedly. And Europe is completely stagnant.
- Corporate profits (S&P 500) are set to decline for the fourth quarter in a row according to S&P 500 Q4 earnings estimates.
- With much of the rest of the world in stagnation or with falling growth rates, and with 43% of S&P 500 revenues coming from outside the U.S., it appears to be a stretch to believe that profits will rise by the 9%+ rate that analysts currently project.
- The forward PE ratio is already stretched at 18x and is troubling because forward earnings are projected to grow so unrealistically in 2020, especially after four quarters in a row of falling profits. Let’s not forget that at this same time last year, those same analysts saw S&P 500 profits rising almost +12% in 2019. Compare that to reality.
- With productivity also contracting, and with no pricing power, corporate earnings have another hill to climb, as corporate margins are negatively impacted under such circumstances.
- Excluding the consumer and government, the U.S. economy has stalled. That’s mainly the business sector. We know for certain that the manufacturing sector is in recession.
- We also know from export data that world trade has contracted. Now, markets will blame this on Trump’s tariffs, but from my lens, that is just an excuse. The export data contraction is too severe to have been caused just by the tariff skirmishes.
- Inflationary pressures on the prices of goods and services have been quite weak. What little we currently see have been caused by the mild rise in the price of crude oil. The actions of Saudi and its allies to curb production in order to raise oil prices to guarantee a successful Saudi-Aramco IPO is what led to the slight rise in such prices. Because the U.S. shale industry keeps on growing production (17.8 mbd in 2019 vs. 15.5 mbd in 2018) and the additional supply coming from the likes of Norway and Brazil, oil prices will be hard pressed to rise in 2020. Combined this with slowing world demand (unless, of course, the world economies simultaneously reaccelerate as is the current narrative), and it is almost a certainty that oil prices will fall in 2020.
Conclusions
I don’t see the real time evidence that growth will reaccelerate in 2020. What happens to markets if reality disappoints? The fact is, equities are priced, not for just recession avoidance (i.e., muddling along at 1%-2% GDP growth), but for accelerating growth into the 3%-4% range. The current evidence just doesn’t support such growth. Can always hope….
Markets rose in 2019 for the reasons I described at the top of this article, not due to the economic or corporate environment. It is very possible that this can continue. But, without any gauges or guides as to when markets might revert-back toward more traditional valuation metrics, it does appear that new money going into the general indexes is at risk. “The Wall Street Casino” descriptor seems appropriate.