Trademark Market Perspective for January 3rd, 2020

What a difference a year makes!   The year-over-year gain from Christmas Eve 2018 to the same day in 2019 was close to 40%![1]  We went from a panic over both Fed interest rate policy and the trade war with China to being completely relieved on both fronts.  The markets were certainly buoyed last year by a Fed that not only cancelled planned rate hikes but later cut rates three times.  The “quantitative tightening” that began in December 2016 was decisively ended.  We know now that rates will be maintained at unusually low levels until either inflation soars or we have an asset price bust and conclude that super low rates were the cause.  In other words, since neither event is imminent, you can expect low rates for the foreseeable future.

It should always be remembered that markets may sell off 5-10% at virtually any time for almost any reason.  In an environment in which liquidity is the main determinant of trading patterns on any given day, a shallow sell-off can happen at any time.  That said, the path of least resistance when liquidity is plentiful, and the Fed is friendly, is upward.  The kind of market pullbacks to worry about occur when the investing public has used up a lot of its “dry powder” and is very enthusiastic.  Despite the market surge in 2017, we really didn’t see a pull back until January 2018.  The 10% correction from February to March of that year flattened the “animal spirits” allowing for the market to recover those losses gradually over the next six months.  Gradual gains are the best kind, in terms of future performance.  Surges tend to lead to speculative excess then hard declines.

I believe we are at an inflection point now.  It’s my opinion that stocks will either endure some profit taking in January or the current rally will intensify. If we experience a market contraction, it will allow low conviction investors to sell thereby laying the groundwork for a healthier intermediate term advance as those investors ultimately buy back into the market. If the current rally intensifies, I believe a blow-off-top scenario in which a hard, painful, correction becomes likely.

Current Positioning

It appears that the bulk of investment strategists see the economy improving in 2020 and as a result see little upward pressure on interest rates and commodities like oil and metals.  We are seeing a little of that now, though I don’t like trading on any trends at the end of the year because they easily could be reversed early in the new year.  (It should be noted that there was very little tax motivated selling in 2019 because there were not a lot of losses to take).

I am not leaning into any “reversion to the mean” trades right now.  By that I mean I’m not presently overweighting value or small caps or international stocks now, despite the popular theory that these groups have underperformed for years and are therefore likely to outperform going forward.  The economic powers-that-be seem willing to deploy everything at their disposal (including negative interest rates) in order to make sure we never have a full market cycle, so betting on a recession (which punishes all investors but those in richly priced and money losing businesses the most) doesn’t seem to make a lot of sense.  Eventually it absolutely will come but trying to predict when is just too hard.

Big Picture Thoughts

1. If you are bullish on the market because of the U.S. China trade deal, you are misguided.  This is a public relations deal to placate the public in both countries.  The reality is that the United States has decided to pursue a “we win, they lose” economic policy to combat the “they win a little, we win a lot” economy policy China has pursued for the last 25 years or so.  There is no way an investor can consider this change bullish.  I’m not saying the change is right or wrong, I’m saying that the U.S. will now pursue policies that hurt China economically just as long as they are expected to hurt us a lot less.  That is a meaningful departure from Bush-Clinton-Bush2-Obama, and it will NOT lead to greater global growth.  For more read the current Economist article “Poles Apart”.

2. We are in an era of monetary policy asymmetry, which means that the Fed will be quick to pursue monetary solutions to economic weakness, but they will be very slow to react to inflationary pressures. In the short run this is positive for stocks, as maintaining excess liquidity encourages speculation (it is cheaper, and the consequences of failure are less severe).  In the long run, it hurts the economy because it encourages companies to channel cash flow into financing activities (buybacks, dividends) as opposed to more productive areas like research and development.  Why does this matter?  Lower economic growth.  Today the U.S. has a hard time staying above 2.5% GDP growth (consensus for 2020 is 1.8%), whereas the second half of the 20^th century saw growth average over 3% annually.  Growth employs more people and leads to rising wages; financing activities benefit shareholders (hence the record high share of pre-tax national income earned by the top 10%)[2].

3. I recently read an article on China Mobile[3] which discusses the reasons investors don’t want to invest in emerging markets value as a theme. The article discussed how a Chinese state-owned enterprise (SOE), is being handcuffed by the Chinese government (which wants all three domestic telecommunications companies to flourish).  The author points out that if a company operates more efficiently but is not allowed to earn an excess return for its superior execution, what is the point?  Very often close analysis reveals that “value” stocks have low P/E multiples for a good reason.

4. I am as excited by the strong performance of the technology sector as anybody else, but there is a maxim that states that the more capital that flows into a sector, the lower the long term returns in that sector. Tech has drawn a LOT of money over the last few years which is great, but I’m old enough to remember how much it took in between 1995 and 2000 and how well that went for investors who got in late.

Disclosure

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[1] Source: YCharts.com, S&P 500 Total Return, 12/25/18 – 12/25/19

[2] Source: Bureau of Labor Statistics as cited in JPMorgan’s Guide to the Markets 1Q2020, p 19.

[3] China Mobile, A State-Owned Enterprise with State Mandated Mediocre Results, Gene Chan, 01/02/2020