Liquidity trumps the economy, which in turn trumps whatever you think of Trump
2019 was unusually volatile and contentious for risk assets. Coming off a near-20% bear-market decline at the end of 2018, stocks would struggle to new highs, only to fall back, before the strong rally into year-end. Chances are we continue the market melt-up, followed by volatility, probably due to politics and geopolitics. And yet, we remain in a long-term buy-and-hold secular bull market, featuring low inflation, Fed accommodation, and infrequent and/or mild recessions. Even though the expansion has set a record for longevity, growth has been subpar, helping prevent excesses (more below). Prior to the election, it will be very difficult to fall into a recession. Anyway, one factor trumps all others: liquidity. Given recent actions by the Fed, European Central Bank and Bank of Japan, which collectively have expanded their balance sheets by more than $1 trillion, it would take extraordinarily bad news or unexpected developments to turn stocks south on a sustained basis. Smaller central banks have stepped up, too (82% of moves were rate cuts last year), while China’s central bank lowered reserve requirements this week for the eighth time in two years. Fiscally, government spending across the globe is providing the biggest stimulus since 2009. With markets awash in liquidity—in the U.S. alone, the money supply is growing at a 10% annualized rate—and the yield curve steepening, TIS Group thinks it looks like late 1999/early 2000, when stocks went parabolic.
The economy ended 2019 with OK holiday sales, consumer confidence in record-high territory and new highs for home and stock prices. And it entered the new year with several favorable structural forces in place. First, productivity has improved and is now rising at one of its fastest clips of the entire recovery. With unemployment at 3.5% and few signs of inflation, Leuthold Group wonders if we’re getting a “recovery-extending” productivity miracle. Second, the labor-force participation rate has suddenly improved and could continue to rise in the next few years. Third, after suffering an outsized decline primarily because many millennials delayed marriage, the household formation rate is surging as their average age rises above 30 years and both nuptials and home buying are now in vogue. Leuthold says the biggest financial risk, and perhaps the biggest potential surprise, could be an inflation rate that recovers much more quickly and aggressively than expected. (I will believe that when I see it.) But it concedes the aforementioned structural changes have created an era of “low and stable” inflation that have and should continue to allow stock market valuations run higher than pre-1990 norms. This is what a secular bull looks like.
Since 1949, the six years that saw S&P 500 increases of 29% or more (it rose 29% in 2019, with a total return of 31%) were all followed by stronger real GDP growth the next year—and higher markets, too, as growth drove S&P earnings higher. Yet far from euphoric, bottom-up price targets remain unusually low. The current mean price target for all S&P constituents implies a 2020 gain of 7.2%, which Evercore ISI says would fall in the bottom 10% of historical readings. In Citigroup’s latest survey of buy-side clients, the weighted year-end 2020 average for the S&P was 3,217, below today’s level at this writing, and 75% of respondents deemed the bottom-up consensus 2020 earnings-per-share growth estimates of 9.8% to be too high. Their weighted average was for just 3.5%. Wall Street’s current 55% average allocation to U.S. stocks vs. the benchmark range of 60%-65% has, on a historical basis, seen positive total returns over the subsequent 12 months 94% of the time, Bank of America says, with median 12-month returns of +20%. Post-crisis investor flows have been consistently negative for equity funds and positive for bond funds. Flows for both have been positive of late, but the gap between bond and equity flows has never been wider. This has helped prevent the degree of multiple expansion for stocks that would represent not only a cyclical risk, but a secular risk as well. The Wall of Worry lives on.
Even though corporate debt is at record levels, borrowing costs remain low, tracking the decline in global bond yields. Both Baa and high-yield rates have been in a downtrend for most of the past decade, with Baa yields near their long-term cycle low and high-yield rates in the bottom 4% of their historical readings. This is what a secular bull looks like. Citing broad-based internal breadth on a global scale, Oppenheimer expects the S&P to keep rallying this year, based on the index’s typical trajectory in the second year following a major market low such as occurred in December 2018. Year two is when doubts tend to recede, fundamentals such as earnings growth revive and some optimism returns. Since 1929, the market enjoyed positive returns 77% of the time in elections with incumbent candidates. The election season should prove deliciously interesting with lots of volatility. Whatever, the economy is strong. And liquidity trumps it all.
What else in 2020
A growth regime until proven otherwise Following 40 years of value outperformance between 1940 and 1980, the relationship versus growth changed when rates peaked on a secular basis in the early 1980s. More recently, value has taken on brief leadership roles when yields rose in 2013 and 2016, but growth has proven resilient to oscillating rates. Overall, until the direction of interest rates turns meaningfully higher, Oppenheimer views growth as a core long-term position and value as a trade. And while cyclicals could aid in an expected melt-up this year, growth’s earnings and cash flow are just too strong to change the growth regime that’s been in place over a decade.
Without a boom, you don’t set yourself up for a bust Ten years into this expansion, discretionary spending for consumers and corporations is still below historical averages. This is highly unusual compared with previous cycles. The lack of willingness to spend on consumer durables and corporate capital expenditures is a reason this expansion has been so weak, and why it could continue for many more years.
A deliciously interesting election season After-tax, after-inflation income growth in the first three years of Trump’s presidency has been the strongest since the Nixon administration. This metric has been the best predictor of whether an incumbent gets re-elected … Bernie Sanders is the favorite to win the first three states in the Democratic primary: Iowa, New Hampshire and Nevada. No candidate has lost the nomination after winning two of the first three states … Biden sees South Carolina as his firewall and current polling suggests this is the case. But this polling is not meaningful until voters decide in Iowa and New Hampshire. If Biden suffers in the first two states, he likely will be downgraded by South Carolina voters, and others who do well in the early states will be upgraded. The odds of a brokered Democratic convention continue to climb.
Who doesn’t love dogs? The so-called “Dogs of the Dow” strategy that calls for buying the past year’s worst Dow performers is not so much a method of buying stocks that are down sharply as it is a way to buy stocks with high dividend yields. To that end, while the Dogs of the Dow approach over the past 15 years or so has beaten the market only about half the time, it has produced meaningful excess returns since it was popularized by Michael B. O’Higgins in 1991. Further, when considering total return rather than absolute performance alone, the Dogs of the Dow tends to be a winner.
Happy New Year! The collective net worth of the world's 500 wealthiest individuals jumped $1.2 trillion last year to $5.9 trillion, a 25% increase in just 12 months.