2020 is right around the corner and that means it’s time to start thinking about what the year will bring and what it means for investors. Financial Sense Wealth Management spoke to Gina Martin Adams, chief equity strategist at Bloomberg Intelligence and to Greg Weldon of Weldon Online to get their take on what to expect in the new year.
See Slowdown Behind Us, Says Bloomberg’s Gina Martin Adams for audio.
Political Risk and Changing Fed Policy
It’s possible that November marked the beginning of a bullish upswing in stocks. Markets powered forward in November, Martin Adams explained, and risky investments finally dominated risk-off plays.
Political risk is always a major factor that can impact the markets, though Martin Adams doesn’t think impeachment will have much of an impact based on historical precedent. A U.S. impeachment has come into play twice post World War II and was only meaningful for stocks in 1998. She explained that impeachment is only significant in an environment where economic growth is rapidly deteriorating. A growing economy allows for markets to better absorb shocks, which could be what’s happening currently.
In this environment the earnings growth outlook is incrementally improving and easy Fed policy is also acting as a shock absorber (see 'Thin-Air Credit' Spikes in the Fourth Quarter). And this is the key difference between 2018 and 2019, Martin Adams pointed out, as the Fed has made an extraordinary policy U-turn this year.
“This year, the Fed has been easing,” Martin Adams said. “That to me has made a big difference. Borrowing conditions are easing. The interest rate is lowering. Spreads are tightening. And that's really helpful in greasing the wheels of liquidity in the financial system, which has certainly helped elevate equity prices and allowed us to ride the bumps of policy, ride the bumps of earnings growth and economic indicators a little bit more easily in 2019 relative to 2018.”
Multiple Corrections This Cycle
With consumers doing well, wages rising and unemployment at low levels, there isn’t much to indicate a major correction is imminent, Martin Adams said (see Global Leading Indicators Are Turning Up, Favor Risk-On Tilt). It's still difficult to see where a rapid increase in growth is going to come from, she continued, but it is important to keep in mind that, over the course of the 10-year economic cycle, we’ve seen several very large market resets.
The equity market effectively priced in three different recessions over the course of this 10-year economic cycle. There was a massive correction last year of 20 percent in stocks, which typically only occurs inside a recession. We also had the 2015 to 2016 correction and the 2011 correction. Each time the equity market has anticipated problems and weakening economic conditions, we’ve seen the economy pull back up. No recession has materialized as a result.
“It is necessary to distinguish between the economy and the equity market,” Martin Adams said. “They are two different entities. They don't always operate in tandem. The equity market has its own cycle and the economy has a different cycle. Our economy is obviously in an extended cycle of very slow growth and very limited inflation.”
Fed to Continue Focusing on Balance Sheet
Martin Adams said the Fed is on hold when it comes to interest rate policy, and it’s unlikely that rising rates will curtail economic activity in the near-term. In the fall of 2019, the Fed focused on its balance sheet and where equilibrium interest rates should be in line with economic and inflation conditions. For Martin Adams the greatest change has been the Fed’s normalizing of its balance sheet after two years of tightening.
The Fed is clearly data-dependent, and if growth deteriorates or inflation spikes unexpectedly, they’re likely to take a quick action on rates. But for the foreseeable future, Martin Adams doesn’t see this happening.
“I think 2020 will really be about the balance sheet,” she said. “The Fed will be faced with determining how fast to grow the balance sheet, how to manage the balance sheet, and what they are doing with the balance sheet while they likely hold interest rates steady. … But I do think that the balance sheet is probably the Fed’s main focus from here until at least the first few months of 2020.”
Manufacturers vs. Consumers
The ISM Index has indicated a further downtrend in manufacturing while services and consumers both appear to be holding up well. This isn’t necessarily a cause for concern, Martin Adams said. The industrial sector is simply more sensitive to changes in economic growth. Even in a recession it’s rare to see a contraction in consumer spending, which slows but does not turn negative.
In contrast, manufacturers rarely slow down their pace of order growth in response to a perceived slowdown in ultimate demand growth. The result is usually economic recession, she said. There has been some slowdown in manufacturing over the course of the last year. Capital goods orders growth—which is Bloomberg’s favored measure of manufacturing activity—has fallen incrementally over the course of the last several months in comparison to its pace from a year ago, but this tends to happen frequently throughout the course of business cycles.
Despite this slowdown, consumers are still spending at a healthy pace. This is creating a sheltering effect, Martin Adams explained. There hasn’t been a confirmation of the weak ISM signal from other manufacturing surveys, she added.
“That’s very consistent with those other periods of equity market weakness that were unaffiliated with economic weakness,” Martin Adams said. “It’s consistent with the 2015 to 2016 experience or the 2011 experience, when the market reacted to a slowdown in manufacturing activity, but the consumer held in there, and held in there at a relatively robust pace. The result was the economy only felt a little wiggle rather than a recession.”
Safety Giving Way to Risk
Safe and yield-providing sectors led much of 2019, but now the market rally has broadened and deepened as it heads into 2020. Throughout the vast majority of 2019, there was widespread denial that markets would continue to rise. Between perceived political and trade policy risks, investor confidence was dampened even as markets were rising. With a recession no longer imminent, the market is rallying beyond expectation and investors want to get in on the move higher.
Investors were crowded into low-volatility, defensive, dividend-yielding stocks with very low market beta, Martin Adams said. When the yield curve started moving in a more positive direction and the Fed began decreasing interest rates while expanding its balance sheet, those trades were caught offsides.
The recovery and market breadth in favor of cyclicals and away from defensive sectors gives a pretty solid degree of confidence that market gains are likely to continue going forward, Martin Adams said.
2020 is a year full of uncertainties from political and trade risks to a November presidential election. 2019 began at a generationally oversold level with absolute rock-bottom levels of investor confidence which lead to many gains, though they’ll be harder to come by in 2020.
“We still think 2020 will be an incrementally positive year, though certainly not (comparable with) the year that we just had,” Martin Adams said. “We are expecting a single-digit gain in stocks as implied by our fair value model. And we do think investors want to start to orient their portfolios toward more cyclical names, as opposed to the very highly defensive strategies that really dominated at least the middle portion of 2019.”
A Hiccup in Consumer Discretionary?
Adding to 2020 uncertainties, Greg Weldon pointed to weak consumer discretionary figures. The S&P 500 and SPDR XLY ETF don’t show a particularly strong consumer. Cyber Monday posted a huge number at $9 billion, which is roughly equal to the year-over-year growth rate in non-store retail sales on a rolling 12-month basis.
Preceding the holiday season, firms had room to cut prices, which gave flexibility in a competitive market. For consumer spending that may not grow as much as it has in the past, Weldon explained, there was vicious discounting to reach that $9 billion dollar mark.
This might suggest that the consumer may already be spent and could mean a shortened holiday season this year. The impressive Cyber Monday sales may have set up for huge expectations that could ultimately prove disappointing, Weldon believes.
Hidden Inflation Ahead
Core inflation is around 2.4%. However, this is discounting hidden increases in expenses like parking, bus fares, childcare and rent. These are not optional expenditures and price increases will eat into consumers’ purchasing power in 2020.
If there isn’t growth in income, there won’t be any growth in discretionary spending. There’s currently a contraction in discretionary spending as necessities such as those mentioned above become more expensive.
Retail sales for September were disappointing and it was chalked up to tariffs hitting, however, October saw similar numbers with weakness in every discretionary spending area except non-store retailers and eating and drinking establishments. These are the expenditures consumers typically hold out on giving up until the end, Weldon pointed out.
On top of this, he said, average weekly earnings are down almost one hundred points from their year-over-year high, which was 3.6%. It’s wonderful if workers are making more per hour, but if they’re working fewer hours and taking home less on a weekly basis, that’s a problem. The 0.2 real average weekly wage gains on a year-over-year basis is down from a real growth rate of almost 2% a year ago.
“These numbers are glaring,” Weldon said. “I think the yellow caution flag is waving wide and high on the U.S. consumer right now. And this is a big deal for the stock market.”
Serious Trouble for the Dollar
Weldon believes the recent downturn in bond yields and the most recent flattening of the yield curve is another yellow caution flag. When the curve previously flattened in 2019, the U.S. bond premium didn’t narrow against Europe. Instead, European yields fell faster, and the U.S. premium expanded to record highs of almost 300 basis points.
In the first week of December, there were declines in bond yields and massive downside reversals in yields across the yield curve spectrum. Now, yield differentials against Europe are narrowing dramatically, violating the two-year exponential moving average on the long end, which signals serious trouble for the dollar. The year-over-year rate of change in the dollar has gone from nine percent to virtually zero very quickly, Weldon added.
“We've been looking for this and waiting for this all year, and it hasn't happened until just recently,” He said. “If we take out this 95.50ish level in the dollar index, and it's a major secular long-term breakdown against the recent rally, even into 2016 to 2018. … This is where it gets really interesting. As the dollar’s cracking here, we have an emerging currency crisis to South America that no one's even talking about. And the dollar is still breaking. … To me, this is a sign of inherent weakness in the dollar.”
Good Sign for Precious Metals?
Another way of looking at dollar strength is to compare its value against how much gold it buys. The dollar gold-ratio is down 15% year-over-year. This represents a large depreciation in currency terms, and bodes well for some of the commodities, Weldon said.
Silver has now made a big correction down to its 200-day moving average with some, like Jeff Christian at CPM Group, putting out an intermediate buy signal on silver in recent weeks. We saw the first breakout, the big turn, the correction, and now we're coming off that level. All the while, despite expectations that gold wouldn’t hold up, the reverse has held true, as it has kept its medium-term moving averages, Weldon stated, followed by a mini double bottom. If it heads above $1520, the correction is over. If the Fed is going to be more aggressive going forward, followed by the ECB, there could be a very bullish setup for gold.
“Gold has been an upside leader,” Weldon said. “If the dollar's cracking, and silver is leading gold, the mining shares are leading the metals, and the Silver Miners ETF (SIL) is leading everything, then that's your perfect alignment of bullish calculations for gold.”
To listen to this podcast, see Slowdown Behind Us, Says Bloomberg’s Gina Martin Adams, or for a full archive of past shows, visit our Financial Sense Newshour page.
Written by Ethan D. Mizer