“Far more money has been lost by investors preparing for corrections or trying to anticipate corrections, than has been lost in corrections themselves”
-Legendary Fidelity Manager, Peter Lynch
As we close out 2019, we close out the first decade of the 21st Century. Gee, that sounds like something. Given the decade started coming out of the lows of the Great recession of 2008-09, it provides us an opportunity to look backwards before we look forward to what may be in store for us ahead.
Unlike this time a year ago, investors headed into the holiday in better spirits, anticipating new trade agreements in North America, Europe, and across the Pacific, hoping to boost business activity in 2020. Progress seems to being made in the US/China trade war, and Brexit seems to be more certain.
The decade of 2010-2019 was a decade of record high debt. … which followed a global crisis created by? … too much debt!
It was a decade in which the inequality of both wealth and income, got even wider, not only in the Western world, but between developed and emerging markets. It was a decade where, despite recovering global economies and all-time lows in unemployment rates in many nations, interest rates collapsed as yields fell to not only record lows, but a couple of dozen of nations on the planet Earth actually have negative rates, and the pile of negative yielding bonds topped over $20 trillion, or 25% of all investment grade debt.
It was a decade where the US dollar gained against virtually all major currencies, but most so against those of emerging markets. There was a major increase in global asset prices as interest rates collapsed, but especially so for equities and real estate. And it was a decade with one major anomaly: It was the first decade ever in history, ever, without a recession. While some may argue we had a couple of twists in 2011-12 with Europe, or 2016, or even Q4 2019 … none dropped US GDP to negative rates. In fact, for the 2000’s decade, US GDP averaged 1.9% while in the 2010’s, it averaged 2.3%.
However, the past decade had been a difficult one, for many reasons:
- While economic growth has been positive, it has been disappointing
- We’ve had periods of great volatility in markets this past decade, along with periods of eerie calm, but market volatility, in general, may have been some of the lowest on record
- The IMF’s World Economic Outlook estimates real world GDP for 2019 was 3.0% , vs. a decade average of 3.7%, and 3.9% for 2000-09
- In Europe, growth has been non-existent. Indeed, for example, Italy’s GDP is about EUR $1.6 trillion, which is pretty well where it stood in 2002. In other words, there has been no real Italian GDP growth for almost two decades
- Japan? Not much better than Italy, and their markets still have not got back to the highs seen in 1990.
- Latin America? It has a decade best to be forgotten. Brazil had a major political shock and economic crisis. So did Argentina. Even Bolivia and Chile have been swept by political instability. But none could match the disaster better known as Venezuela
For certain, the past decade was one of decay. Despite incredible technological innovation, it saw a global slump in productivity – and one which produced a lot of theories as solutions- but little concrete action. The lack of solid GDP growth around the globe, coupled with an explosion of debt, will have structural implications going forward.
The composition of markets changed the past decade as well. As you can see from this chart of the largest global companies by market cap, there’s been a dramatic shift, not just from 2010 to 2019, but look back to 1980, 1990, and 2000.
Unlike the 1990’s and early 2000’s however, one noticeable difference this cycle is the savings rate. In the prior cycles people responded to the ongoing improvement in the economy and job market by saving less and less. Now, many are playing it safe, and the relatively higher savings rate sets this economic expansion apart from the others.
Now this time of year, you will be inundated with forecasts of what’s in store for 2020. I like history, and here’s how the Dow Jones and S&P 500 perform in years after they ring up gains of 20%+:
- Since 1950, it’s happened 18x, 15/18 were profitable the years after
- Going back to 1950 (70 years), the Dow Jones climbs in 75% of the time, with an average of 8.9%
- The S&P 500 gains an average of +11.2% when it finishes the prior year >20% and gains 83% of the time. 2019 was up almost 30%
- The Nasdaq returns 14.2% and is positive 78% of the time
(Source: Dow Jones Market Data)
One of the mistakes investors repeatedly make is to confuse what happens in the headlines with what concerns the stock markets. Markets have a mind of their own, and what they are primarily concerned with is earnings and interest rates. In the long run, it’s just earnings. The rest? Just noise.
It’s not just amateurs who fall to this, in 2009, the Wall Street Journal famously had an op-ed piece warning us that “Obama’s Radicalism is Killing the Dow”. That article came at the exact low of markets.
On election night in Nov. 2016, as the futures plunged, Nobel Prize winning economist Paul Krugman wrote “If the question is when the markets will recover, a first-pass answer is never”. Well, not exactly.
Now, it’s impeachment headlines. With only two in modern history, we don’t have a lot of data points to work with. President Clinton was formally impeached on Dec. 29th, 1998. He was acquitted Feb. 12th, 1999. This one gets complicated markets wise, because Russia defaulted in Aug. 1998, which led to a collapse of the hedge fund Long Term Capital Management in September. That shook the markets, and the S&P 500 closed below 1000 on October 9th.
In Nixon’s case, it was more serious, even though he resigned before he was formally impeached. There was a lot more going on in 1973-74 like the OPEC oil embargo, the 1973 Yom Kippur War, and the resurgence of inflation. On top of that, the USA officially entered a recession in Dec. 1973 on the day Nixon resigned. The Dow closed at around 577, its lowest point in the last 55 years!
In 2019, things, despite what it may seem like, are much calmer, US GDP is 2.0%+, and the outlook for a US recession in 2020 seems remote, so far 2020 looks like it will begin with more of what we’ve seen do far through this expansion – just perhaps slower economic growth and slower market appreciation.
I don’t see a US recession in 2020 for many reasons, but the main ones are:
- The US economy is still adapting to the lower Trump tax rates
- The Fed remains dovish and likely to do zero in 2020
- US homebuilders don’t have enough in inventory to keep up with population growth
- Bank balance sheets are solid with ample excess capital
The biggest risk would be if a far left candidate wins the White House in 2020 and the Democrats get a majority in the House and Senate. While that will happen one day, I don’t see it this time around.
Shorter term, we might be due for a break or small pullback as the CNN Fear/Greed Index looks stretched:
Looking further out, here are a couple charts I thought were important to illustrate both the Bull and Bear cases:
The following helps the bear case. The Ratio of Total Market Cap to GDP is at levels not seen since the 1999 cycle high. You can see shorter term peaks in the 1973-73, 1987, 1999, 2007, 2001 and 2016 … all shorter term peaks.
The following helps the bullish case. This one shows the money flows into ETF and equities. Novice investors tend to buy at the top and sell at the bottom. Happens each and every cycle! As you can see here, investors have been net sellers of equities for some time now, and that usually does NOT happen at tops. When compared to the last two cycle tops of 2000 and 2007, we are not even close.
Back to those forecasts for 2020. You will see the words “uncertainty” or “unprecedented” in the titles. I’ve been involved with investment markets since the early 1980’s. If my memory serves me well, we have lived in so called “unprecedented” times with markets dealing with “unprecedented” conditions every single day for the past 40 years.
I get asked all the time about what markets will do going forward. In the immortal words of JP Morgan once said when asked:
“It will fluctuate”
Because as Old Turkey said to a young Jesse Livermore in “Reminiscences of a Stock Operator” (1923):
“After all, this is a bull market”
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