2020 Outlook

‘THE STOCK MARKET just keeps on climbing and Federal Reserve boss Alan Greenspan is making a massive amount of money available for the economy. Greenspan has engineered the biggest expansion of money supply in the Fed’s history in the weeks leading up to the end of the year. The Fed’s move has been explosive on Wall Street because a free-flowing money faucet at the Fed is the stuff that makes bull markets get fatter.’ – Wired Magazine…. 1999

The markets took a dip at the end of 2018. The bond yield curve had been invented. There were other telltale signs that the economy was headed south. Investors were right to start 2019 on a cautious note. Luckily for them, 2019 turned out far better than most had hoped. So, what changed in 2019? 

The Good…

The stock market ended last year strong. This is to be expected at the peak of a mature market cycle. Aside from market returns, there are several other economic indicators that were positive as well. Since 2017,  job numbers, household earnings and corporate profits have all increased. The unemployment rate has fallen to its lowest level in 50 years.

A large part of this growth, especially in the corporate sector, can be attributed to the Tax Cuts and Jobs act of 2017 (TCJA). The TCJA cut tax rates for most taxpayers, though those gains went mostly to corporations and the top percent of income earners. The acting chairman of the Council of Economic Advisers, Tomas Philipson, has claimed that ‘the tax cut… is responsible for the great labor market we have right now’. 

Another positive contribution to the economy was the ‘Phase One’ trade deal with China. This deal promised to reverse the tariffs imposed in 2018. This ‘Phase One’ deal was promised several times throughout the last year. Each time a deal was announced, the market responded accordingly. Fidelity’s most recent market analysis concluded that, ‘During Q4, favorable policy developments – including further monetary easing by the Federal Reserve and de-escalation of the US-China trade confrontation – provided additional fuel to power stock markets to a strong finish in 2019.’

… the Distracting 

It’s been a tough year to pay attention. There are distractions everywhere. That seems to be the point. Fatigue also seems to be another objective. Everyone is tired of the constant news cycle we’ve been living through. 

The obvious elephant in the room is the Impeachment of the President. There have been scandals that would have ended any other presidency over the last three years. As the issue of impeachment arose so soon into President Trump’s term, I looked into how the impeachment process could impact the markets for my clients. As my research predicted, investors did not seem to be concerned.

Part of that may be the fact that we’ve been living with impeachment as a backdrop for years. After reading the Mueller Report last April, I made the high-minded assumption that Congress would want to address the concerns put forth by the Special Counsel. The report, which brought up numerous transgressions of ethics and law, failed to capture the attention of the public. 

The market declined by 6.6% shortly after the report came out, but May is often a month where declines are common. Equities began a steady climb into record territory starting in June. The end of the Mueller investigation may have put many investors’ minds at ease. Unfortunately, the pattern of behavior that was outlined in the report should have warned us all that more was to come. Impeachment will come to an end soon, but I doubt the distractions that accompanied the process will remain. Those distractions are more of a threat to investors than anything else.

The Bad

The sheer amount of information available to investors makes sifting through the data a daunting task to begin with. In recent years, it’s become even more difficult to disseminate fact from fiction. The hyper-partisan environment we find ourselves in has produced volumes of information that can confirm just about any bias out there. 

In my last quarterly newsletter, I brought up how perception can influence consumer sentiment. There was a noted change in people’s attitude regarding the economy after the 2016 election. This change was clearly delineated along a partisan divide. One of my main concerns for 2020 is that the Presidential election could arbitrarily change opinions of the economy for the worse. 

That’s not to say a change in perception would be unwarranted. Far too much of the recent economic reporting has been carefully skewed to reinforce one position or another. One example of this is the reporting about recent gains in the start market. While 2019 was a good year for the market, most reports ignore the fact that the market was starting at a low point following a sharp decline in 2018.

When we step back and look deeper into the numbers, we can see that the market is only up 9.9% from it’s peak back in September of 2018. While these gains are obviously positive, that does not mean all is well with the economy. Most people often assume that if the market is good, the economy is too. A better tool to measure economic conditions is the Gross Domestic Product (GDP). 

Unfortunately, GDP is only measured quarterly. While the stock market provides current feedback, GDP takes time to disseminate data. We’re just now learning that GDP only increased by 2.3% in 2019. This is far below the political promises of 5% annual growth

Because of this lag, we only know after the fact when the economy is in trouble. Financial professionals rarely spot problems until after the fact. At the start of 2019, over half of the nation’s CFO’s were concerned about a downturn. At the start of 2020, 97% of CFO’s believe an economic downturn is imminent. Are they right? We won’t know until afterwards.

What we do know at this point is that several warning signals are present. The U.S. ISM Factory Index fell to its lowest level since 2009. Bond yields have inverted again. Debt is exploding across the nation. The founder of NorthmanTrader, Sven Henrich, recently pointed out that , “In the last decade the US added nearly $11 trillion in debt while growing GDP by only $7 trillion. In other words: Every $1 in growth came with over $1.5 in additional debt.” Our federal debt is now 152% of GDP.

Low bond yields and the dangers of crippling debt are a major factor behind the rise of the stock market. Simply put, holding debt is higher in risk than the rewards can justify. This has funneled money into stocks. That’s a big part of why we’re seeing growth in equities… there’s not many good alternatives right now.

That alone cannot explain the stock market growth. Perhaps the biggest investment story of the year has been quantitative easing (QE). You may recall QE from years after the Great Recession. QE was used to jump start the economy back then. You may be asking yourself why we’re doing QE now that the economy is doing so well. That is a great question.

Frankly, it appears that the non-partisan Fed has been bullied into doing so. It appears that QE is being used to create a desired political reality. The chart above shows how the Fed injected billions of dollars worth of cheap money into the economy. The markets responded to this easy money accordingly. 

Looking back at Greenspan’s comments above, we can see the same Fed policy in play today. The easy money gave investors the money they needed to fuel the dot com bubble. The best sector in 2019? Large tech companies.

You may have not noticed any of the concerns I bring up. That seems to be the point of all the distractions in the news lately. We’re being asked not to look to carefully at facts, or worse, to ignore them completely.  My advice is this. Don’t take any more risks than you need too.  

And pay attention!

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