A Positive Outlook for Stocks in 2020
The foundation for continued growth in stock prices is intact, but in moderation. Catalysts for economic growth are all flashing green: low interest rates, low oil prices, deregulation, increased deficit spending, higher employment and higher real estate prices. Offsetting these positives are the measures of U.S. and global business and investor confidence. Confidence is declining due to policy confusion, trade wars, tariff hikes. The Administration’s erratic and personalized policy goals and foreign relations is losing allies, friends and supporters. Unilateral trade wars have proven to be more difficult than expected, reducing confidence and inhibiting coordination with other countries. However, it is too early to give up hope; it is an election year after all, and new types of economic stimulus could easily be proposed.
As we are now in a seasonally strong period for the market, we are willing to ride out the current equity allocation as there does not appear to be a better investment alternative. Economic surprises could be around the next corner: new tax cut proposals, favorable new investment rules and concessions regarding trade deals are all possible. Fundamentally, we are still in a bull market for stocks and patience is required.
Technically speaking, the stock market is trending upward after breaking out of a multi-year base in October. The Dow Jones Index projects to a 30,000 to 31,000 target by mid-year, a 5% to 8% increase from current levels. If the market chooses to correct, there should be initial support at 28,000 followed by strong support at 27,400. We remain fully invested and look for buying opportunities on dips.
Figure 1 – Stocks Broke out to the Upside in October, Too Early to Pick Tops
The Prospects for Global Growth are Improving
The recent U.S. China Phase I trade deal signals that trade confrontation is over at least through the election. The elimination of this risk is a positive for corporate decision makers and should help stimulate growth globally in the short run. However, it is unlikely that there will be a comprehensive Phase II trade deal that limits China’s ability to acquire intellectual property. The world is likely to move towards a “decoupling” of U.S. economic co-dependence with China. This should result in dual global standards and dual spheres of economic control, a bad outcome for future economic growth. However, over the short term, most global regions are poised for improved growth.
United States. The United States economy closed the year on a strong note in 2019 and could do even better in 2020 supported by the Fed, fiscal stimulus and trade deals with China, Japan, Canada and Mexico. Trump’s push for energy independence could benefit the U.S. competitively for years to come. The recent Fed comments supported the view that the Fed will not raise rates in 2020 and possibly longer until inflation sustains itself above 2%. Inflation is unlikely to increase significantly due to: global competition; major technological advancements leading to significant productivity gains putting a lid on unit labor costs; disruptors popping up everywhere; and easier regulatory restrictions.
Tax Cut Proposals are in the Cards. Treasury Secretary Mnuchin mentioned that tax cuts are still very much on the table for 2020. We’re hearing that Larry Kudlow and other Trump Administration insiders are scrambling to come up with policies to combat any economic slowdown prior to the November election. Expect to see more trial balloons on what could be in a tax cut or infrastructure package.
China. Since Phase I of a trade deal has been finalized, the government has moved to stimulate its economy big time by announcing an additional major fiscal stimulus and a cut in the reserve ratio by 50 basis points. This will cause banks to reduce their lending rates and add much more capital to the system. It is clear to us that China’s economy bottomed out in December and 2020 growth could surprise on the upside.
Britain. Having secured a workable Brexit deal, the United Kingdom may turn out to be the winner in its divorce from the European Union. The U.K. benefits from a long transition period and growth exceeds 2% as foreign direct investment resumes now that the outlook is clarified. The EU economy remains soft, and European markets other than the UK underperform the U.S. and Asia. U.K. equities are likely to rise in the interim.
Eurozone. The Eurozone is still battling its problem of zombie banks with ultra-low (negative) interest rates. With Brexit almost behind it the Eurozone needs fiscal stimulus to find economic traction. A trade deal with the U.S. would be constructive. Deregulation and labor law reforms would be helpful in stimulating economic growth. Germany is overdue for a leadership change.
Japan. We expect Japan’s economy to do better in 2020 bolstered by aggressive monetary ease, fiscal stimulus exceeding $120 billion and increased trade as global trading tensions ease.
Earnings Needs to catch up with P/E Multiple Expansion
The S&P 500 rose almost 29% last year in anticipation of future earnings growth. This happened even though corporate revenues only rose 2% and earnings declined by 1.5%. Significantly lower interest rates in 2019 were the catalyst for P/E multiple expansion. When demand for stocks exceeds supply, the rise in stock prices can be described as an expansion of what investors will pay per dollar of earnings: P/E (price to earnings). In 2019, the P/E multiple rose from 15.6 to 18.3 over the course of the year. This P/E expansion is unlikely to reoccur in 2020 as it is near a historic high. For the stock market to move higher, earnings growth will have to improve.
Figure 2 – The P/E of the Stock Market is at Near Record High
As described in FactSet, S&P earnings are expected to grow 7-8% during 2020, with most of that growth expected to be in the 2nd and 3rd Quarters. Earnings gains should be led by industrials, energy, materials and consumer discretionary companies. S&P profits are expected to increase to an annualized rate of 7-8% to well above $178/share by year end 2020.
In my opinion, earnings growth should be the catalyst for reasonable, but not great, stock market performance in 2020. If interest rates remain low, P/E multiples could remain high, allowing the earnings expansion to drive the market. Trump will do everything in his power as standing President to boost the economy and stock market heading into the election in November.
Figure 3 – Earnings Growth is Expected to Rebound by 7-8% in 2020
Federal Reserve Policy Remains Friendly to the Market
The Federal Reserve cut interest rates 3 times for a total of 75 basis points to 1.50% in 2019. No further rate cuts or increases are expected in 2020. They have cut rates not due to a weak domestic economy but as a result of inflation running well beneath expectations for so many years and an overly strong dollar. As the economy improves in 2020, long-term interest rates are expected to move slightly higher. The path for interest rates is likely to be sideways between now and the election.
Housing Growth Should Continue to Rebound
As seen in Figure 4 below, single-family home sales have rebounded from their 2009 low, but are not yet back to long-term historical rates of growth. With low interest rates and increasing demand from Millennials for starter homes, I expect housing to be a source of expanding economic growth in 2020. As Millennials come of age, we expect them to start families, buy houses and get into a lot of debt. They should be a catalyst for economic growth over the next decade.
Figure 4 – Single Family Homes Sales Should Continue to Improve
We are maintaining our positive outlook for stock markets in 2020 as we still see an acceleration in global growth supported by significant easy monetary conditions. We should continue to see increased fiscal stimulus in major industrialized countries; and reduced trade tensions leading to improved global trade. While we fully recognize the ratcheting up in geopolitical tensions on 1/3/2020, we have not altered our overall views.
We remain optimistic that U.S. economic growth will average greater than 2% into 2020. Low unemployment and growing consumer spending should be the primary catalysts. It is hard to see much of a slowdown with well over 2 million jobs created over the last year combined with meaningful real wage gains. We continue to believe that Trump will do all in his power to bolster economic growth at least through the Presidential election in 2020.
Investment Themes for 2020 and Beyond
We remain fully invested in the stock market. We have shifted more towards industrial, energy, real estate and consumer stocks both in the U.S. and foreign markets. While we are concerned that a correction could occur at any time, we believe that the economic fundamentals would constrain it to a 5%-10% correction. We remain overweight in U.S. exposure versus the rest of the world.
Our fixed income exposure remains benign. We are taking less credit risk and have added to higher yielding mortgage ETF’s and high-quality corporate debt. Our average maturity remains short in the 2-3-year range. In our opinion, the size of the potential federal budget deficit and corporate refinancing needs necessitates keeping maturities short and waiting for higher interest rates.
Overall, I believe that the rally may continue through this Spring followed by a period of digestion and base building. We are data dependent and looking for interesting income opportunities.
Scott P. Noyes, CFA CFP®, is the President of Noyes Capital Management®, LLC, an independent fee-only wealth management firm based in New Vernon, New Jersey. Please visit our website at www.noyescapital.com
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