New Year, Markets and News

361 Capital Market Commentary | January 6th, 2020

Thirteen months ago we had trade wars, a government shutdown, Fed tightening and broken credit market worries to take with us on our winter holidays. Last month was much different and I hope that your only concern was finding the right-size ski boots or flip-flops. Of course, it would have been completely worry free if not for the New Year’s drone strike which has raised tensions in the Middle East.

What a year 2019 was. From the Sum of all Fears to No Fears. It was definitely a Tom Clancy happy ending if you had fully invested in risk assets for the 12 months. Even better if you stuck to the mega cap missiles of U.S. large cap tech stocks. But for those of us who run hedged or opportunistic portfolios, it was a Defcon 1 environment. Cash was a difficult asset to own and short hedges were poison. I don’t know too many opportunistic investors who shifted to fully long after the Fed changed course 12 months ago. I was still pretty cautious given the broken credit markets and rapidly deteriorating earnings environment. In other words, I fought the Fed (and the Fed won).

So where do I think we will go in this New Year?

  • Well, most importantly, the Fed still has our back. Not only is the Fed allowing the economy to run a bit to try and push inflation out of its doldrums, but they have even been adding liquidity to the system to help with the short-term repo markets. Any liquidity is good liquidity so keep an eye on this.
  • Iran/Iraq/The Middle East? Few know exactly how this will evolve. It seems like most of the world wants less tension but it will be up to the White House to decide where to take it. I get many calls and emails when a geopolitical event like this occurs and my feedback is typically that it is tough to make major portfolio decisions around the direction of the news. Usually it is better to take a counter-trend trade and buy the names that get hit rather than panic out of them.
  • U.S. and global earnings growth will likely rebound in 2020 with the China trade wars ending and hopefully global trade resuming quickly. While stocks have been rewarded in the Q4 for anticipating this outcome, positive earnings revisions for future quarters should help the markets appetite for further gains.
  • There will still be worries and concerns for investors to be on lookout for… China Trade deal phases 2 & 3. EU Trade spats. Iran/Iraq. Inflation moving higher faster. Central banks return to tightening. A downturn in credit. The 2020 election. We saw in Q4 of 2018 when a few major concerns in the market caused a 20% pullback in the equity markets. While anything is possible, it does seem unlikely that many of them will once again emerge at once.

The markets are highly unpredictable and few can tell you where it will be in 12 months. It is better to focus on owning good stocks, good strategies and good managers for the long haul. Tilting the weights in the portfolio is fine to do if you are uncomfortable with a size or want to be more opportunistic about a better outcome. Here’s my take on portfolio tilts:

  • Value stocks > Growth Stocks. I am a long term growth stock investor and believer so this is tough for me to write. Nothing wrong with keeping your big winners if you are in love with them and don’t want to pay taxes. I just think that on the margin, after underperforming for 10+ years that Value will post better numbers.
  • Smaller Caps > Larger Caps. Twenty year low relative valuations makes this an easy bet for me.
  • International Stocks > Growth Stocks. Better valuations in International Developed. Better Growth in International Emerging. And if the U.S. Dollar underperforms, international stocks could get a turbo boost if fund flows follow.
  • Like the Global Trade names which have been held back by the China, EU and NAFTA trade skirmishes. Industrials, Materials and Semis could all benefit as global trade restarts.
  • Like Healthcare names that have demographic growth but have been paused by Government price and control worries. With the right Democratic candidate this spring, the names could resume their recent trend higher.
  • If you have big gains in your Bonds, REITs, Utilities and Staples securities, you might look to them as a source of funds.
  • Lots of fans of Energy due to the broken valuations and recent rise in Middle East tensions. I would be very selective if you are picking stocks. U.S. shale has yet to prove out its profitability. And the increasing threat of global warming is only going to further put the industry into the world’s crosshairs. I’d prefer to play the oil commodity or the broken debt of higher quality energy companies.

As long as the Credit markets remain healthy and the central banks are looking out for the world’s financial markets, we should be fine owning some risk assets right now. As the markets move and evolve, I’ll be here to let you know if there is something that we need to look at more closely. I wish you much prosperity and luck in your 2020 portfolios.

Also, I will be hosting a webcast reviewing 2019 and providing an outlook for 2020 this Thursday, January 9. Register Now.

Visually, that is a great eleven-year rip…

S&P 500 Price Index

The 2019 move was all multiple expansion…

Just as the 2018 move was multiple contraction. Eliminate the Trade Wars, the Government Shutdown and the Fed reversal and the two year multiple moves probably disappear.

S&P 500 Total Return Attribution

The biggest contributors to the S&P 500 were the mega cap tech names…

Top 10 contributors
(Goldman Sachs)

In fact Tech as a sector contributed 1/3 of the entire gains for the S&P 500…

@hsilverb: $SPX: Information Technology accounted for 31.4% of the $SPX 2019 total return, as $AAPL and $MSFT accounted for 15.0% of the $SPX return, 20.2% for December 2019 (IT was 33.8%), and 8.5% from 2009

S&P Dow Jones Indices

Speaking of Apple…

Apple now worth more than US energy sector

Apple’s AirPod business alone might be worth more than most of the companies in the Energy sector…

1. Sanford Bernstein analysis suggests that AirPods revenue doubled in 2019 coming in at ~$6B and their base case assumes that Apple will generate ~$15B in AirPods revenue in 2020.

2. This assumes that half of the entire first-hand iPhone installed base purchases AirPods. With 60% wireless penetration, Bernstein estimates Apple will sell ~$85M AirPods next year.

3. Bernstein believe that consensus estimates could be $4-8B too low potentially leading to upward revisions down the line.

And not just equities, but all asset classes won in 2019 (just as they all lost in 2018)…

@edclissold: What a difference a year makes. In 2018, 0/8 asset classes were up 5% for the 1st time since at last 1972. In 2019, all 8 were >5%. The median gain of 20% was the highest since 1982. The minimum gain of 9% was the highest since 1982. #dontfightthefed @NDR_Research

How Hard Is It To Find Winners

Again, central banks helped saved the day…

Global Money Supply USD

Financial conditions are wide open to risk taking…

The Goldman Sachs U.S. Financial Conditions Index is arriving in 2020 at a very healthy level. Treasury Bond yields are low, credit is healthy, the stock market is doing well and the U.S. Dollar is weakening.

GS US Financial Conditions Index
(Goldman Sachs)

And the worst of the credit markets (junk bonds) are also wide open…

Bloomberg Barclays US Corporate High Yield to Worst

High-Yield Bond insurance is very cheap right now…

HY CDX Spread

The U.S. Dollar index looks to be headed lower which has many implications…

@tpetruno: Trump wants a weaker dollar for US exporters, and he’s getting it: DXY index of the dollar’s value vs major foreign rivals is falling. It’s now at lowest since June. Good for exporters, but bad for US consumers’ purchasing power. A trend to watch in 2020.

DXY Index

U.S. equity valuations are not cheap…

Free-cash-flow yields look cheap but that is only because capex is running well below trend.

Free Cash Flow

U.S. stocks have never been more overvalued relative to the rest of the world…

US stocks at 70-year highs versus global stocks

U.S. stocks have tripled the returns of international stocks off the 2009 low. So it may be time a good time for more foreign stock exposure…

MSCI All Country World ex-U.S. and S&P 500 indices

And could the Eurozone be making a bottom here?

Markit Eurozone Manufacturing PMI

Interesting to see how poorly Berkshire Hathaway’s stock performed in 2019…

@tpetruno: Shares of Buffett’s Berkshire Hathaway $BRKB rose 10.9% in 2019, badly lagging the S&P 500’s 28.9% gain. Berkshire trailed in part because Buffett & crew hoarded billions in cash rather than invest it. Just remember: He didn’t get rich following the crowd.

BRK.B Daily

Especially since Berkshire’s equity portfolio did so well…

@therealjunto: Lots of criticism of Buffett underperforming. Let’s actually compare apples-to-apples. Buffett’s stocks were up ~44% in 2019. S&P was +31.5%.


Peter Lynch also had a challenging 2019…

Barron’s had a great interview with him at the end of December. Still very active and involved with the markets.

On the other hand, he says, 2019 has been “the worst relative year I’ve ever had in 50 years. I’m up, but I’m not going to give you the number. The market is up 29%. I’m nowhere near that.” Still, the market’s steep advance since he retired, Lynch adds, “reinforces that growth stocks are better than nongrowth stocks. The turnarounds, the cheap stocks, if you’re right, sometimes you make a double or triple. But you’re not right that often.” Growth stocks are those “where the sales have really grown” at least 15% a year, not to be confused with higher earnings. Earnings gains, he warns, can reflect turnarounds that don’t rise to the level of actual growth.

Investors’ narrow focus on Microsoft (MSFT),, Alphabet (GOOGL), and Apple suggests that “there’s a real shortage of growth companies,” he adds. “That, to me, is a red flag; all the money is flowing into them. There’s an end to that game. It will scare me if this trend continues for a couple more years.” So, where are the opportunities? He won’t name names. But he says, “If you cannot find growth companies that are in the third, fourth, fifth inning of the ballgame, look at turnarounds, look at special situations. If I were doing this today, I’d probably be flying to China and Japan every two months. Maybe the United Kingdom. Maybe France.

He believes that oil, energy services, and natural gas can provide triples. “You wouldn’t know it from the stocks, but oil is 25% higher than a year ago,” he observes. “Why have these stocks gone down? Everybody’s assuming the world’s not going to use oil for the next 20 years, or five years, or next year. The private-equity money wants out. The banks want to cut back their lending. They can’t do an initial public offering.”


Speaking of energy stock performances…

WTI Crude Oil vs Energy sector performance

Bespoke had this good chart showing the concentrations in the sector ETFs…

So maybe you are just better off buying the top three or four names in a sector if you are an industry investor and avoid the turnover and tax issues of the ETF.

Am I Diversified

Semi and Technology stock investors will like this chart showing the upcoming pop in 5G handsets…

JPM are raising our global smartphone forecasts for 2020 and 2021 on account of their expectations for strong 5G global smartphone adoption. JPM are raising our 2020 and 2021 global smartphone forecasts to +4% y/y and +3% y/y, respectively.
(The Market Ear)
Global Handset Shipments and Y/Y

Good work from The Leuthold Group highlighting Small Caps at 20-year low relative valuations…

Median Valuations For The S&P SmallCap 600

Small caps will also get the benefit of a bounce in value stocks (Industrials, Financials, Materials, Healthcare) if you also want to tilt to that style…

Small Cap Sectors

Speaking of value stock discounts…

Forward Earnings Spread between Value Stocks & the Market

One positive for U.S. value stocks is that private equity funds have lots of idle cash looking for a buyout…

Number of U.S. listed companies

Where are current portfolio managers over/underweighting their books?

FMS positioning vs. history

Jared Dillian thinks 20% of U.S. colleges and universities will not exist in 10 years…

The reason: demographics. Basically, an echo of the baby bust of the early seventies. I was born at the bottom of that baby bust in 1974. My small generation hatched a small generation, which is now making its way through college. Enrollment will drop 15% on average, on top of the eight-year correction that schools have already experienced. This may not seem like much, but finances at colleges and universities have deteriorated sharply, and many of them will not even be able to withstand a drop of a few percent…

The demand for higher education has been relatively inelastic, but demand elasticity is starting to set in. Today, 45% fewer 18- to 29-year-olds say going to college is “very important” than in 2013. A 45% drop in just seven years. I talk about it incessantly on my radio show. Higher education has become so expensive that it makes practically no sense for anyone, except as a luxury purchase for the idle rich. Not even a Wall Street job is going to be any help in paying off $200,000 to $300,000 in debt.
So we have fewer students going to college and fewer students wanting to go to college. Right…

Schools will resort to lowering standards to keep enrollment up, but that is a race to the bottom, and the value of every student’s degree will decrease correspondingly, setting off a vicious cycle that makes college even less attractive. My suspicion is that universities—allegedly with very smart people in charge—have done pretty much zero to prepare for the coming bust. Many schools have lots of debt, not much cash, and a lot of fixed costs. Almost nobody has prepared for what is about to come next. And this is operating under the assumption that the Department of Education continues to be as willing to lend money as it has been in the past.

As an investor who came of age in a bear market, I tend to look for bear markets. We have had some wingdingers in the last 20 years. This one will be up there, with pretty profound economic effects. Colleges and universities employ a lot of people and in many cases are the lifeblood of a single town. You’ve probably noticed that the nicest buildings in your town are the academic buildings. Wait until they are all empty.


Baby Booms and Busts

The age of new car buyers is zooming higher…

A durable pattern has emerged for U.S. licensed drivers: Fewer young people (as a percentage of those eligible) are registering to drive, while more older people remain registered. Every U.S. age cohort under 60 has seen its percentage of licensed drivers decrease since 2001 — and every cohort older than that has seen its percentage increase. Not surprising, then, that car buying has also tilted older. In 2007, almost half of all buyers of new light-duty vehicles were under the age of 45. In 2017, more than half were over the age of 55.
Older by Half

One factor is that the total cost of owning a new car is not cheap…

It’s going to cost more for those looking to buy a new car this year. Finance costs on new car purchases have jumped 24% in 2019, according to new AAA research, pushing the average annual cost of vehicle ownership to $9,282, or $773.50 a month. That’s the highest cost associated with new vehicle ownership since AAA began tracking expenses in 1950 and a reminder that the true costs of owning a vehicle extend far beyond maintenance and fuel.


And as the nation’s youth pulls the total population towards urban centers, there is less need for an automobile…

Among the reasons for the national decline are migration to dense urban areas; young adults’ preference to live close to their jobs or to use alternate modes of transportation; more online working, shopping and streaming; and a growing population of retirees who don’t commute to jobs anymore.

For decades, the country’s driving pattern moved in sync with the economy. People drove more when times were good. They cut back when recessions cost them their jobs.

Now, however, we’re driving less even though the economy has been expanding for more than a decade.

“In the midst of a fairly substantial economic recovery between 2009 and 2017, we’re seeing a decline in person trip-making, which suggests that something pretty fundamental is going on here,” said Brian Taylor, a professor of urban planning at the University of California Los Angeles.


Poplulation Towards Urban Centers

Fred Wilson is a great thinker and money making VC. His top ten list for the next decade is definitely worth a read. His first point could not be more spot on given what is going on in Australia right now…

1/ The looming climate crisis will be to this century what the two world wars were to the previous one. It will require countries and institutions to re-allocate capital from other endeavors to fight against a warming planet. This is the decade we will begin to see this re-allocation of capital. We will see carbon taxed like the vice that it is in most countries around the world this decade, including in the US. We will see real estate values collapse in some of the most affected regions and we will see real estate values increase in regions that benefit from the warming climate. We will see massive capital investments made in protecting critical regions and infrastructure. We will see nuclear power make a resurgence around the world, particularly smaller reactors that are easier to build and safer to operate. We will see installed solar power worldwide go from ~650GW currently to over 20,000GW by the end of this decade. All of these things and many more will cause the capital markets to focus on and fund the climate issue to the detriment of many other sectors.


Where is the Amazon of the energy sector?

If the major Energy companies would have invested more into sustainable energy, maybe their sector relative market cap would not be challenging all-time lows.

Too small to matter?

Catch up on past Weekly Research Briefings >