Large cap US stocks were the best performing primary asset class in 2019. What a difference a year makes!
Despite all of the concerns about Brexit, trade wars with the Chinese, inverted yield curves, dysfunction in Washington, and the Federal Reserve, 2019 was one of the least volatile years in the stock market in recent history.
US economic activity was better than advertised at the end of 2018. It wasn’t great, but it was okay enough to drive stock prices higher.
In 2019, a lot of people probably heard the phrase ‘inverted yield curve’ for the first time. While most probably couldn’t explain what one is, they knew it wasn't good for economic growth.
You can sum up 2019 by simply saying:
"Don’t fight the Fed."
A Few Predictions for 2020
Next year, the US economy will grow modestly, in the 2% range. The US consumer should be strong enough to ‘offset’ a slowdown in the ‘private fixed investment’ portion of the GDP equation (C+I+G +/- NE).
The Federal Reserve would like to be able to ‘sit this one out’ in 2020, and not have to move the overnight lending target in either direction. It WILL have to continue to provide liquidity in the repo market and will NOT be able to shrink its balance sheet (unwind quantitative easing). In fact, it will likely have to grow it slightly over the course of the year as there are too many Treasuries to finance and too few players with the means of doing so in the overnight market. Combined, monetary policy will be neither restrictive or accommodative…simply practical.
Expect a more modest 6-8% return on US stocks next year. This is the proverbial low-hanging fruit forecast. Throw a 5% ‘equity risk premium’ on top of the 1.90% yield to maturity on the 10-Year US Treasury Note and voila! Tricks of the trade my friends.
There is little reason to believe there will be continued ‘multiple expansion’ in 2020. In 2019, the price/earnings ratio on the S&P 500 increased from roughly 16.5x at the beginning of the year to about 21.5x by the end of it. This was due to the decline in interest rates, thanks largely to the US Federal Reserve (let alone other major central banks). Typically, stocks can ‘support’ a higher absolute valuation (i.e. a higher P/E) when interest rates fall…otherwise known as multiple expansion. IF interest rates aren’t falling and the Fed isn’t cutting the overnight rate, etc., it is hard to forecast higher valuations for stocks. This takes us back to more ‘normalized’ return predictions, like the one in the previous bullet point.
So, if the US market should grow 6-8% next year, what does that make the range with the S&P 500 at roughly 3,220 at year-end? 3,413 - 3,478. Now, what is the chance of that being right? I would give it the flip of a coin, but it is a reasonable, explainable return assumption.
If the Fed is on hold and if the rest of the world’s central banks aren’t in a hurry to do anything either, currency trading could be pretty boring in 2020, with the US dollar trading in a relative tight range against a trade-weighted basket of primary currencies. The moral of the story? If the dollar isn’t going to weaken sharply, it is hard to recommend realizing a bunch of capital gains by selling US stocks to, say, double your international allocation. However, after years of continued underperformance, the easy money betting against international stocks might be over…might. That is NOT an endorsement as much as a statement of the obvious.
Expect a decent, positive year in the markets with one caveat: it is likely going to be more volatile than 2019 was.
A well-diversified balanced portfolio should expect a 5-7% total rate of return; however, it proves to be a roller coaster ride, with politics taking center stage.