Coming off the blowout in non-farm payrolls in the US on Friday (266k new jobs added vs 180k consensus and 156k in October), the US equity markets ended last week with a bang. The S&P500 closed the week with a 200 point gain, bringing the 4Q-to date (Dec 6) gain to 5.3% and the YtD gain 20.3% (excluding dividends which would add around 2% annualised). This continued strong performance in the US equity markets, in spite of slower GDP growth and slower earnings growth (not to mention the on-going trade war with China), is a reminder to me of how bleak things looked only one year ago, as the Fed’s hawkish stance had rattled the equity markets and convinced many investors that a recession was on the horizon. The two tables below compare select market and economic parameters as of 4Q (to date) for 2019, versus 4Q2018, which was poor.
As you might recall, the recession in the US that was expected and “priced in” during 4Q2018 did not materialise in 2019, as equity investors piled back in the stock market to start the new year. Indeed, investors shook off their fears as expectations for both economic growth and corporate earnings growth were lowered, and then the economy and companies delivered in line with the lowered expectations. The Fed did its part, too, not only by not raising rates further, but then turning dovish as economic data weakened; the Fed lowered the Fed Funds rate three times, in July, September and October, further appeasing investors as a “soft landing” became the expected outcome. The Fed also showed its dovish stance by in another way, ending quantitative tightening in August that had reduced the Fed’s balance sheet from $4.5 trillion to $3.8 trillion during 2019, And in fact, the Fed then de facto resumed what some might consider an altered form of QE in September as the money markets seized up in the US (for reasons I never really understood), pumping the market with another $300 billion of liquidity and increasing the Fed’s balance sheet back to $4.1 trillion. We are approaching the end of 2019 with an equity market performance in the US that few expected one year ago today, and this obviously raises the question of “what now?” I am not sure what to think, since there are a tonne of risks on the horizon, but also plenty of offsets. Here’s my list.
The Risks
- Trade war continues with China / other countries, and is closer to expanding than to ending
- Growth is slowing in China, and remains anaemic in Japan and Europe; the U.K economy remains locked-down by ongoing BREXIT discussions and a pending election
- Credit concerns are growing in the market as companies unabashedly take “nearly free money” from the Fed to leverage themselves. Corporate debt has nearly doubled since the “Great Recession”, approaching $10 trillion. And consumer debt is also growing, reaching around $14 trillion recently, slightly higher than during 2008
- Wealth inequality is growing, supporting a populist backlash that could tilt the electorate towards a fairer and more socialist approach which could show itself during the upcoming 2020 presidential election
- Government debt is growing because of the combination of interest expense on the growing federal debt and lower tax revenues, courtesy of the Trump tax cuts – a fiscal stimulus – even though the economy was growing nicely already
- The impeachment hearings are escalating, and will likely result in #POTUS being impeached by the House (although its seems unlikely by the Senate currently)
- The stock market has rallied throughout this year, raising questions about whether such strong returns can continue into 2020 as earnings growth continues to slow
The Good
+ The US economy is in good shape. GDP growth is slowing, but unemployment remains at historically low levels and payrolls are growing; inflation also remains in check in spite of near record-low interest rates and a very accommodative Federal Reserve
+ This is an election year, and the current administration will use every tool in its arsenal to ensure that the economy does not weaken prior to the election
+ The trade war continues to be a distraction and drag on the economy, but it can be de-escalated relatively quickly should the current Administration choose to do so
+ The new year is likely to bring new money into risk asset classes, likely supporting both the bond and equity markets as the new year kicks off
+ The Fed remains “data dependent” and dovish for the time being (although it has signalled further rate cuts are unlikely)
+ The slow down in corporate earnings growth has been well-managed as far as aligning expectations with what has occurred
+ Stock market valuation metrics, e.g. the Schiller and P/E ratios, remain at reasonable levels. The dividend yield on the S&P500 is slightly higher than the 10-year UST, providing further support
It’s a tough call – what do you think lies ahead for the US equity markets in 2020?
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