Monthly Markets Memo - January 2020
by Dan Zalipski, CFA
The Chinese delegation signed the ‘phase-one’ trade deal on January 15th in Washington D.C. The deal has China buying large amounts of U.S. agricultural goods. China has also made assurances that it will begin to reform some of its longstanding and controversial practices surrounding forced technology transfers and intellectual property rights. Should China honor their side of the agreement, the U.S. will begin to roll back some of the tariffs that have been imposed over the past 24 months.
In other news, the Federal Reserve released their minutes from their December meeting. In summary, after cutting rates 3 times in 2019, the Fed is not expected to make any adjustments to interest rates in 2020. With the phase one trade deal in place, and the Fed on hold for the year, the two primary sources of 2019’s volatility appear to be resolved.
As we look forward to 2020, we see new topics stealing the spotlight, and potentially driving volatility throughout the year. Let’s start with valuations. Stocks traditionally have two ways to climb higher. The first is earnings; if the company’s profits increase, it’s stock price can follow. Earnings growth for 2019 was essentially flat, suggesting that earnings did little to lift stock prices during the year. This brings us to the second way stocks can climb higher, multiple expansion. A stock’s multiple is simply how much an investor is willing to pay for future earnings. Multiples can expand and contract with the market’s appetite for risk. One popular multiple, price divided by forward earnings, or forward P/E, is one of the more common multiples investors use to gauge if stocks are expensive or cheap relative to both their own history and other asset classes. The S&P 500 index started 2019 with a forward P/E of 14x, well below its 25-year average of 16.3x, yet finished the year at 18.18x. This expansion fueled much of 2019’s gains, but also pushed the multiple above historical averages, indicating stocks are expensive relative to their own history. In other words, additional gains due to multiple expansion is less likely. This refocuses forward expectations for stocks on 2020 earnings. Earnings estimates for 2020 are coming in at mid-single digit growth. With multiple expansion unlikely to contribute to returns, investors are left with moderate earnings growth estimates to drive returns, which explains the general theme of lowered return expectations for 2020.
Muted earnings and market forecasts do not necessarily translate into muted volatility. With valuations sitting as high as they are, there is little margin for error in terms of negative surprises. One event sure to generate some volatility this year is the U.S. Presidential election. The election has potential for far-reaching impacts on energy, technology, healthcare, and of course, taxes. As campaigns progress, candidates drop out, and potential policy proposals develop, investors will begin to gain clarity as to how the election may impact their portfolios.
Despite the consensus of lower expected returns for 2020 compared to 2019, there is a silver lining worth mentioning. Investors and analysts agree that the chance for a recession in 2020 is practically zero. The Fed has extended the current bull market through last year’s interest rate cuts and stimulus programs. Global growth is expected to rebound from this recent soft patch. U.S. earnings estimates are positive, unemployment remains low, and the U.S. consumer is confident. We may be cautious with current valuations but remain optimistic that the U.S. economy will remain resilient, and that the expansion will continue.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendation for any individual. Although general strategies and / or opinions are revealed, this post is not intended to, nor does it represent or reflect, transactions or activity specific to any one account. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results. All data and information is gathered from sources believed to be reliable and is not warranted to be correct, complete or accurate. Investments carry risk of loss including loss of principal. Past performance is never a guarantee of future results.