Changing Gears: Outlook for 2020

Delwin Graham - Dec 13, 2019
The current year is drawing to a close, and we are tempted to provide a market prognostication for the next year. There is risk involved because the future is almost never how we imagine it to be.

December is a dangerous month for Investment Advisors. The current year is drawing to a close, and we are tempted to provide a market prognostication for the next year. There is risk involved because the future is almost never how we imagine it to be. Recognizing this, I will let other braver souls lead the predictions for 2020.

Javed Mirza, the Technical Analyst at Canaccord Genuity, is bullish. He argues that we are in the middle stages of a long-term secular bull market in equities (Cf., Javed Mirza, “Predictions for 2019 as a New 4-Year Cycle is Poised to Take Hold”, Technical Perspective, Canaccord Genuity, January 1, 2019). Whereas the S&P 500 broke out of a 10-year trading range in 2013, he sees the current positive trend continuing through 2020 and into 2030. Of course, the ride is never smooth, and this long-term trend will be made of a series of short-term business cycles, typically lasting about 4 years. According to Mirza, a new 4-year cycle took hold in December 2018 when the U.S. Federal Reserve enacted a series of interest-rate hikes, raising expectations of a recession. The S&P 500 fell approx. 12% in December, and the yield curve briefly inverted in early 2019. This set the market bottom (Phase 1), and the subsequent year saw the initial stages of a market recovery (Phase 2), as the S&P 500 has gained approx. 25% year-to-date. Mirza argues that 2020 should see a sector rotation out of defensive bond proxies (consumer staples, utilities, communication companies, REITs) and into the more cyclical areas of the markets (financials, industrials, information technology).

Tony Dwyer, the Chief Market Strategist at Canaccord Genuity, is also bullish. He is calling for a short-term target on the S&P 500 of 3440 in 2020, which represents further upside of approximately 8.5% (Cf., Tony Dwyer, “Macro Strategy”, US Equity Research, Canaccord Genuity, December 2, 2019). His positive fundamental core thesis is driven by 1) an accommodative Fed, 2) solid corporate credit, 3) positive inflection in the global manufacturing data, and 4) a buoyant U.S. economy. More specifically, Dwyer contends that the U.S. Federal Reserve will continue to accommodate an open money supply; that is, it will continue to print money. Corporate debt is still widely available and historically cheap. According to several indices (PMI and New Orders), global manufacturing looks to be recovering from very weak levels. And the U.S. economy is stable; there have been no meaningful signs of change for employment, consumer spending, and low lending rates. Whereas the 2011, 2016, and 2018 bear corrections were initiated by fear of the Fed tightening monetary conditions, that is clearly not the current situation. Given this history and his core thesis, Dwyer argues that offensive portfolio management led by information technology, industrials, financials, and consumer sectors should be the way to go in 2020.

That’s the view from 30,000 feet. We tend to manage our portfolios at the ground level, that is, by considering each security separately. We do this because our clients get paid when a stock goes up (or pays a dividend) and not because we are right on a macro-economic level. However, that being said, the top-down market views of both Mirza and Dwyer seem to be borne out by the performance of the stocks in our portfolios. It is certainly true that 2019 was the year of defensive bond proxies. As of December 10, 2019, the approximate year-to-date performance of the consumer staples, utilities, communication, and REIT sectors of the S&P 500 were 22%, 18%, 28%, and 22% respectively. The idea, of course, is that defensive sectors with yield are most attractive to investors when coming out of a market bottom (Phase 1) because these companies are deemed to be essential; that is, they provide food, shelter and warm. But we also seem to be rolling into the early expansion stage of the market cycle (Phase 2), as the financial, industrial, and information technology sectors are up approximately 26%, 25%, and 40% respectively. These companies are meant to profit from an expanding business cycle; that is, they service the companies that are growing their sales. This marks the beginning of the new bull market. The labour and commodity markets benefit in the later stages of the economic expansion (Phase 3). These factors reflect the increasing cost of production, that is, inflation, that will inevitably throttle down the economic expansion and cause the contractionary phase of the cycle (Phase 4) and the beginning of the new bear market. Whereas the consumer discretionary sector has performed well (+21%), indicating that money is available to the workforce, both the energy and materials sectors have lagged the index (+3% and +17% respectively) which seems to indicate that we are at the mid-stage of the business cycle. That’s the hope anyways (Cf., Edward Yardeni, “Performance 2019 S&P 500 Sectors & Industries”, www.yardeni.com, December 10, 2019).

Of course, there are opportunities in every phase of the business cycle – that’s why we roll sectors and actively manage stocks. Please contact me (dgraham@cgf.com; 780‑408-1518) for more details and a few actionable ideas.