Cornerstone’s Week on Wall Street
5 Predictions for 2020:
At the start of a new year, (and a new decade!) we here at Team Cornerstone, have much for which to be thankful. 2019 was a fantastic year for our clients, our firm and for our investment portfolios, and we are very excited about what 2020 has in store! We are most thankful for the opportunity to continue to work for you, our valued clients and friends, and for another year where we can learn, grow, and get better and better at what we do on your behalf.
In this edition of Week on Wall Street, we will publish our 5 forecasts for 2020. In our last note, we reviewed our predictions for 2019, which were more right than not, but stress that these predictions in actuality, have very little to do with our investment results. While many on Wall Street rely on predictions, feelings, charts, lunar cycles or dartboards for making investment decisions, we focus on the process. Fortunately for us, our process does not rely on a crystal ball, tweets, or election results, but on a daily measuring and mapping of high-frequency economic data and market signals. Our process allows us to build a framework for investing to position our clients to maximize the probabilities of positive returns; what we call high probability investing. We would humbly submit that this method is far superior to relying on predictions, feelings, charts, CNBC, you name it; because dispassionate analysis market-moving data is at the heart of what we do. This does not mean that we’ll always be right. But it does mean that there will always be mathematical rigor and sound reasoning for every investment decision that we make on your behalf.
So why release annual predictions? First, communication from the Investment team is a priority for us. We want to share our thoughts on the current state of the investment landscape, and to stretch our thinking and yours about high-impact events over the coming year. Second, while we don’t go through this process with the goal of getting 100% of these correct, selfishly it is satisfying knowing that we have been able to anticipate some of the generally unexpected market-moving events for the coming year. Without further ado, here are Cornerstone’s Top 5 predictions for 2020.
Slow economic growth disappoints forecasts, but the U.S. avoids recession in 2020.
While US GDP growth slowed during 2019, the economy grew by more than 2% for the first three quarters of the year. We do think 4th quarter GDP growth could surprise to the downside, but a strong consumer is more than offsetting a slowdown in the manufacturing economy. The consensus forecast, per Factset, for 2020 GDP is 1.9% growth. While, a phase-one trade deal with China removes uncertainty, an escalation of tensions in the Middle East, an election year, and late-cycle economic dynamics have us in the camp of the 1-1.5% GDP range for the year.
Risk assets can do well in a slower growth environment, but we think diversification and active management will be key in 2020.
Earnings growth falls short of expectations due to late-cycle dynamics.
As of the time of this writing, Factset consensus expectations are for S&P 500 earnings to grow 10.2% year-over-year in 2020. Corporate profits are near all-time highs, but we can’t escape the fact that for the first time since the first half of 2016, S&P 500 earnings went negative year-over-year in the last reporting season. While results were better than initially feared, we think the consensus view of nothing but blue skies ahead is far-fetched. Corporate debt to GDP is also at all-time highs, and Real Unit Labor Costs (ie wages) are growing faster than GDP and are at highs for the cycle. Since labor is typically the most significant cost for a business, this will put pressure on corporate margins. If we’re right on slower GDP growth, top-line revenues could also slow resulting in a double-whammy to the downside for corporate profits.
U.S. stock returns are in the mid-single-digit range; International and Emerging Market stocks outperform.
We find it highly unlikely that the S&P 500 is able to replicate its stellar results from 2019. Since 1928, the average annual return for the S&P 500 is 11.6%. Over that same time period, the index has averaged 11.1% in Presidential election years. In years following a greater than 30% return year, the index has averaged 9.5%. The base rates indicate the odds for a solid year for stocks, but in our estimation, a valuation will likely constrain returns somewhat. On any valuation metric, the S&P 500 is expensive. Some metrics, such as the Shiller CAPE and Price/Sales ratio show the S&P as the most expensive in history! Contrast that with International and Emerging markets that trade anywhere from a 15-30% discount to the S&P, and we favor the risk/reward of stocks outside the U.S.
The next move by the Federal Reserve on interest rates is a cut.
At the most recent Fed decision and press conference, Federal Reserve Chairman Jerome Powell, effectively communicated to the market that the Fed was on hold as it related to changes in interest rates. The Fed dot plots, which are the committee member’s projections on the path of future rates, show no action in 2020 followed by one rate hike in 2021. Powell also reiterated that the committee would remain data-dependent, but that current policy was appropriate to maintain the expansion and allow for the Fed to hit their inflation target of 2%. The futures market, as of this writing, puts the odds at 55/45 in favor of one cut in 2020, not much better than a coinflip. If we are correct on our projections of GDP growth and earnings
coming in below projections, we put the odds of a cut in 2020 closer to 75%. The wildcard is that typically the Fed does not take action in election years to maintain the optics of being apolitical. We won’t comment on the degree to which the Fed may or may not be influenced by politics, but will suffice it to say that it would take an extremely strong person to not be somehow influenced by his boss’s constant disparagement in a public forum, even if it is Twitter. Given that rates in major global economies around the world are all lower than here in the U.S., the path of least resistance is likely lower.
A tumultuous political year is capped off with a status quo election.
2020 promises to be a year for the ages vis-à-vis political theater. There is no doubt that there are serious political divisions in our country, and it seems that the electorate continues to move away from the center. President Trump is also a divisive candidate, who polls very well among his core constituency, and extremely poorly across the aisle. The fact that the impeachment vote in the House went almost straight down party lines and will likely die in the Republican-controlled Senate, is a microcosm of the political environment in the country today. We do not yet know who will emerge as a front-runner for the Democrats, or how the impeachment process may sway independents and others outside of President Trump’s core. If history is any guide, we believe that people tend to vote with their wallets, and it is difficult to find a significant group who are much worse off today than they were 4 years ago, though we are sure they exist. The U.S. economy is strong, yet slowing. Unemployment rates are at 50-year lows, and some sub-groups are at all-time lows. Wages are rising and confidence is high. The political rhetoric is sure to reach a fever-pitch, and uncertainty may contribute to volatility in the markets, but when the dust settles post-election, we think that not much will change.
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This material provided by Cornerstone Wealth Group is for informational purposes only. It is not intended to serve as personalized investment advice or as a recommendation or solicitation of any particular security, strategy or investment. Any securities mentioned herein are not to be taken as advice or recommendation to buy or sell a specific security. The information provided may not be applicable to your account managed by Cornerstone Wealth Group. Please contact Cornerstone Wealth Group for specific information regarding the holdings and trading activity of your account. Opinions expressed in this commentary do not represent a personalized recommendation of a particular investment strategy to you. Additionally, you should review and consider any recent market news. All expressions of opinion are subject to change without notice in reaction to shifting market or other conditions. Data provided is believed to be accurate, but its accuracy, completeness or reliability cannot be guaranteed.
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