Our first daily email of 2020 covers our outlook and views for the year ahead.
Markets ended 2019 in a festive mood, and the positive trend has continued to start 2020, with equity markets powering to fresh all-time highs.
Returns for 2019 were stellar, with shares experiencing the best year since the global financial crisis – the US market (measured by the S&P 500 index) was up +29%, NZ market (measured by the NZX50 index) +30%, Australian market (measured by he ASX 200 index) +21%.
Headlines were dominated by trade wars, astronomical valuation multiples for some technology stocks, the long-awaited crash (and unexpected recovery) in housing across Australia & New Zealand, and importantly – central banks around the globe drastically changing their stance on interest rates, lowering rates to keep the economy and markets moving forward. This was the big difference with 2018, which saw monetary policy tightening.
The chart below from Deutsche Bank highlights the global market moves in 2019.
The optimistic bull investors still have strength in numbers, but an increasing number of negative bears are emerging from hibernation. Those who argue that benign market conditions will continue courtesy of central banks are crossing swords with those who believe markets aren’t pricing in any/enough risks and/or valuations are stretched.
Markets are basking in the after-glow of the partial US-China trade deal and continued encouraging signs of stabilisation in the global growth slowdown.
The China-US trade situation, for the moment looks to be tucked into bed – with the US & China signing a partial “phase one” trade deal last week. There has been a marked de-escalation in trade tensions as we start 2020. However, as we have discussed previously, we believe the rise in power of China will create multi-year conflicts with the US which cannot be solved overnight.
In terms of global economic growth, European industrial activity continues to be held back by the German manufacturing sector, but by contrast the US housing sector still looks to be revelling in the lower level of interest rates over the past year. If there is a return of growth globally, that will also translate into company profit/earnings growth.
Another event which caught headlines in 2019 was Brexit, and it appears as though the Brexit saga is close to ending. In the UK, re-elected Prime Minister Johnson pushed through Parliament a bill to ensure there would be no Brexit extension beyond 2020 even if the UK had failed to negotiate an EU trade deal. While this potentially still leaves open the risk of a “hard Brexit”, markets at this stage seem to be counting on both the UK and EU striking a deal in time.
Markets have digested events at the start of the year with relatively little volatility. There was a short-lived spike in the price of crude oil as US air strikes in Iraq and Syria killed Qassem Soleimani, commander of Iran’s elite Quds Force and architect of its growing military influence in the Middle East. Soleimani, a general, was regarded as the second most powerful figure in Iran.
Closer to home, the Australian Bushfires have large ramifications for a number of Australian stocks, and create uncertainties particularly in the agricultural space.
While geopolitical risks have increased in early January due to the US strike in Iraq, other key risks to the global economy have reduced. The Chinese economy is also stabilising, with the People’s Bank of China supporting growth by cutting its reserve requirement ratio by another 0.5% this month.
Looking at the overall macroeconomic backdrop, central banks around the world (importantly the US Federal Reserve, European Central Bank, and Bank of Japan) have made a commitment to continue to put liquidity and pump up the markets as long as inflation stays low – and as we have highlighted previously we believe a shock of higher inflation is the one major risk for markets, as it will force global central banks to raise interest rates. Lower interest rates for longer around the globe is a key driver of the current rally, and we cannot emphasise enough that the low rate environment is crucial in terms of supporting stock markets at current levels.
In the immediate future, the focus of markets will be earnings season in the US as companies announce their profits for the 4th quarter of 2019. Looking ahead into 2020, it should be easier for US corporations to publish stronger results given they will be compared to a relatively ”weak” 2019 year, as the impact of the Trump Administration’s tax cuts are no longer influencing earnings numbers.
Later in the year it must be kept in mind there will be a Presidential Election in the US, with many market commentators believing Trump will likely be re-elected.
There is likely to be a market reaction as we get closer to the election and as front-runners emerge, in particular, the US election will be an increasing focus if a hard-left candidate wins the Democrat nomination. However, historically markets have usually trended sideways in the months heading into a US election. For NZ based investors, there will also be an election in the latter months of the year here in New Zealand.
Overall, looking ahead we think 2020 will be another year of positive returns for equity markets, but likely at a much more modest rate than 2019 – we are clearly late in the market cycle.
The US Federal Reserve and other central bank narrative appears to outweighing unquantifiable worries about trade war uncertainty, geopolitical uncertainty, and fiscal policy uncertainty. Some major downside risks to the global economy having been avoided, and market concerns over a possible recession are diminishing (barring a major external shock) – we actually believe that global economic growth may gain speed over the coming months.
We agree that stock valuations in many areas look stretched, and continue to favour stocks exposed to our top investment themes such as a rising Asian middle class, an ageing population, the explosion of data, and software as a service. We would like to reiterate that we are medium-term investors and some of our best ideas are ones we have supported for many years.
While we’re entering 2020 with less concerns than last year, as is always the case, there’s never any room for complacency!
