Seeking Alpha

2020 Outlook: Euphoria To Despair

by: Kirk Spano
Kirk Spano
Value + Growth, dividends, Option Income, macro

If euphoria signals market tops, then it seems we are about to get that delusion.

Political uncertainty is a bigger piece of the puzzle than most are giving credit for.

Valuations already are stretched and further stretching can't be supported by easy money alone.

The trade deals will have little impact because AI and machine learning are far more important factors on global trade than politicians who are fighting yesterday's battles.

A first half rally will be followed by a second half correction that could devolve into a very fast moving bear market in Q4.

Since everybody is playing, here's my summary 2020 outlook. As I have discussed before, prognostications, though often accurate, have difficulty providing precise enough time frames to trade. Because of that, I think investors should consider different scenarios, from most likely to least likely, and have a game plan for each.

Our best bet as investors is to understand the most important economic and financial factors, then control our emotions and be willing to adjust as markets move. Here's my summary look at 2020 with some key points. I will discuss several of the key points more in depth in coming pieces.

Euphoria Will Finally Signal A Stock Market Top

As I have discussed with subscribers and clients for several months now, I expect a rally into early 2020 as a result of the mini China trade deal and seasonality. I think it's very likely we see the final "euphoria" before a cyclical bear market greets us later in the year. This is the culmination of a prediction I made two summers ago and mentioned in a "tweet-versation" with Mark Yusko.

Yusko Spano

The underlying problem with many statements that euphoria was already in markets is the desire of many of those folks to want to call the next bubble.

There's a huge group of prognosticators who want the fame that goes with saying "I called the bubble." Since the last financial bubbles burst over a decade ago, people have been calling the next bubbles. I talked about this in a piece two years ago called "A Bubble In Bubble Calling."

That's not to say there aren't bubbles today. The bubbles are just different that what most people think. Hence, the black swan theory.

The idea of euphoria today does not take into account a couple important factors, including that the bubbles probably aren't where we are looking. The circumstances in the markets have changed and a lot is unknowable.

One extremely important factor though, is that, just like after the Great Depression, there's an entire generation, the Baby Boomers, who will never feel financial euphoria again. Why is that? It's a perpetual feeling of financial uncertainty that most of the Boomers rightfully have.

For certain, there are some Baby Boomers who will still chase markets, but they do it in weird ways. There's a passive aggressive nature that's interesting to watch in their investing, simultaneously asking for higher returns and lower risk.

In general, the Baby Boomers, who control most of the money in the stock market, are trickling out of stocks as they retire (in about a decade we will have to face the fire hose). This puts an enormous strain on markets over time. There's no euphoria to ever be had from them again.

Euphoria from younger generations is not to be found in general either. While Millennials and Xers make more than the Boomers did, it's only just barely and has not moved up in current dollars. That is, most wage increases have barely covered inflation the past 40 years according to Pew Research.

Wages vs InflationWhy would anyone have euphoria with that equation?

Continuing with the generational look, the perpetually ignored Xers are a small group without enough firepower to cause euphoria. By the time they have more money, they will want to start spending it. They can't create euphoria on their own now and probably never will get around to it.

The Millennials, though actually saving a larger part of their income to retirement than Boomers ever did, simply aren't making enough money yet. They can't create euphoria on their own either - not yet anyway.

Retirement Savings By GenerationSchroders 11/19

If a combination of the Millennials and Xers can't create euphoria given the developing Boomer offset, what can? It would appear some combination of easy money and corporate buybacks is the answer. And that's just what we are getting into the seasonally strong part of the calendar.

The calendar plays a vital role in a euphoric hot minute. Early in the year, retirement plan money flows in through funds found in 401(K) and other plans. That gets spread around. Breadth expands. And then it ends in the spring. The new meaning of sell in May and go away.

Let's Borrow A Lot Of Money

There's an idea that the Federal Reserve is "printing money" and has been for a decade. Programs like QE and the current repo market bailout are mischaracterized over and over. Alan Greenspan just did it (if you listen to him, he's a contrary indicator).

The reality is that the United States, Japan, Europe and China - the four biggest economies representing about 80% of global GDP - are borrowing a lot of money. That money finds its way into the economy, but also the other side of the balance sheet as debt.

This is an important distinction vs. actual printing of money. The debt offset is deflationary. Given so much has been borrowed from the future, deflation is the real long-term bogeyman, not inflation - as Greenspan wrongly mumbled recently.

In theory, the immediate impact of borrowing is to be stimulative to the economy. Yet, growth is stuck. Why?

The answer is fairly simple. We are running into so much existing debt, on top of aging demographics issues, that the easy monetary policy of low, zero and negative interest rates can't do what Keynes said it would.

That of course gets blamed on Keynesianism and is a false criticism. Keynes also suggested paying down debt in good times, which no government has done in the 40 years except for a hot minute in the late 1990s in the U.S. Are we not in good times?

Federal Budget

The Federal Reserve and other major central banks though continue to try to throw money at the economic growth problem. It doesn't solve anything, but it pushes asset prices up. Why? Because more money in the system today pushes asset prices up today. Milton Friedman told us about this in the 1960s:

Inflation is always and everywhere a monetary phenomenon in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output...

And there's the rub. Output is not increasing enough. So, we have monetary inflation, but without the corresponding boost to output, or GDP. That's a recipe for stagflation if we do not change fiscal policies, in particular regulatory and taxes, to create a more level playing field and collect more revenue to pay the Boomer retirement bill that's coming due.

In the short term however, easy money finds its way into the stock and bond markets, pumping up prices.

The Buyback Bubble Really Will End Badly

In early 2018, right after I correctly called the volatility spike that year, I suggested that "the buyback bubble will end badly." I stand by that prediction and believe the bubble in buybacks starts to unwind in 2020.

Goldman Sachs (GS) already warned us that buyback spending is falling. According to them, second quarter buybacks fell 18% compared to 2018. For the full year, buybacks are set to decline 6%. Why is this important? Buybacks represent all, that is 100%, of all net buying of stocks this year.

For 2020, economic and political uncertainty already is taking a toll on corporate spending. We can see it in quarterly report after quarterly report and in financial presentations everywhere. Yet, the stock market keeps inching out new highs. Those new highs are getting harder and harder to get.

The buybacks cannot continue at current levels unless economic growth picks up. My screening shows that about half of companies with buybacks have been borrowing to finance their buybacks. That bill will have to be paid soon as there is a wave of corporate debt refinancing coming. Companies will continue to adjust their buyback plans in anticipation. (Many low growth, high debt companies will be included in my coming series on stocks to sell in 2020.)

The Federal Reserve and other central banks are not in the business of being tight anymore, so monetary policy will remain accommodative. However, this is the year that more zombies start to run amok. We are already seeing it in Europe, China and the U.S. energy sector. Pretty soon, the zombies will need to die and that will have a knock on effect in the economy and markets.

Ultimately, slower economic growth will lead to zombie deaths and lower profits. Smaller corporate share buybacks will be a result of the lower profits.

An Early Bout Of Volatility Akin To Early 2018

The new highs becoming harder to get achieve should be a harbinger to intelligent investors. It will not take much of a black swan to set off a spike in volatility. Could the China trade deal be not as good as advertised? I think so. Could Q1 GDP growth disappoint? I think it could.

There's likely to be at least one bout of volatility early in the year as many people are in the business of "shorting vol" and whatever black swan pops up won't have to be a really big black swan.

The "short vol" side of the boat gets overfilled once in a while. The perceived catalyst will get the attention for the surge in volatility, however, the reality is that it will simply be too many people selling volatility futures and the iPath S&P 500 VIX ETN (VXX) for the market to handle.

It appears that the trader "50 Cent" is back at it, betting on a rise in volatility in early 2020. I tend to agree with him, but think he might be a month early.

I have made a few successful VIX trades in recent years and a breakeven trade. My fear in betting on VIX is that it's a tough bet for retail accounts because it deteriorates quickly. Timing has to be almost perfect to use it effectively for a short swing trade (or day trades for those inclined).

For most investors, raising cash into and early in the New Year is a smarter approach to hedging. I had that discussion with Bob Savage (formerly Track Research, not head of FX Sales Americas at BNY Mellon) at the Traders Expo in NYC back in January. Simply put, hedging is hard, expensive and requires quite a bit of luck on timing. Most people should "just sell what they think might go down" according to Savage. I agree.

The Trade Deals Really Don't Matter

There's a lot of hot air breathed out about the trade deals. And there's quite a lot to talk about. The main point that most people are missing is that the trade wars are fighting yesterday's battles.

As I've discussed with subscribers, the China trade deal is minor, weak and unlikely to ever be really implemented. China will continue to take what they need and mostly pay lip service to things they don't want to do regardless of agreements.

Back in college I had a Chinese dissident professor tell me that China would string America along for as long as the Communists ran the country. That proved very true. Why would it change now?

The only thing that can more profoundly deal with China is a united front with allies. The TPP, a flawed deal for sure, was a good first step to moving in a unified direction for keeping China at bay. It certainly would have needed constant improving, but walking away from it, has proven to be a mistake.

Ultimately, the whole "they took our jobs" mantra is false in general and very outdated now anyway. Study after study shows that job losses in America were around three quarters due to technology transformation. We should accept that because it's about to happen in again.

AI and machine learning are far more important to manufacturing and supply chain movement that almost anything that government can do with tariffs. What government should be doing is creating a playing field where innovation thrives and capital flows into R&D so that the supply chains move to America.

I will have several pieces at least on these topics in 2020, including stocks to win as the "smart everything world" continues to emerge.

Political Uncertainty And Misperceptions On A Democratic President

We already know that CEOs are adjusting their plans based on political uncertainty. The main issues for them are economic growth and taxes.

Slowing growth is happening for a host of reasons as touched upon in different sections of this piece:

  • Aging demographics
  • Debt
  • Trade wars

The tax issue also is very important to corporations and the wealthy.

Corporations go where their money is treated best. The U.S. is often the place. Our corporate tax code is now more accommodating than it has ever been for them.

What I am about to say people will find strange because I'm not a President Trump fan, but the corporate tax code is almost right currently. Why is that? In my opinion, corporations pass through almost all tax costs to consumers anyway. So, what's the point of raising their taxes other than ideological perception.

A more complex corporate tax code or higher corporate tax rates is not what we need. We ought to do away with most loopholes, but the current tax rates about right and maybe even a bit high. Like I said, raising corporate taxes will just get passed onto consumers anyway. There are other mechanisms for raising revenues.

With that in mind, corporations are concerned that they will in fact see a more complex and expensive corporate tax code in 2021. That's impacting short-term spending plans at a time we need them to invest in things like R&D and modern manufacturing.

Family offices, the domain of eight, nine and ten figure wealth, have been dialing back equity exposure recently. Institutional Investor tracks this fairly well, albeit with a lag to the public.

The core catalyst for family offices to dial back equity exposure is a belief that equity returns will be lower in the 2020s. A recent study State Street Global Advisors suggested returns in the 2020s would come down due to valuations.

That's all on top of fear that taxes could go up in 2021 for the 1%.

If President Trump looks like he's going to lose, equity outflows from the wealthy will accelerate. If he does lose, the wealthy will lock in lower capital gains, then the traders will pile on and the retail side will eventually panic. This is the scenario that could drive the S&P 500 (SPY) (VOO) down to the 2200 level I outlined in a piece titled: How Low Can The Stock Market Go?

SPY RiskAs investors, we should be concerned with the President Trump losing scenario. As I mentioned in another article, I have seen private polling which shows about 10% of Republicans are going to sit on their ballot (or maybe vote for Biden, which could turn into a maybe vote for Bloomberg). The takeaway is that the Never Trumpers are back and that will make it far more difficult for President Trump to win again.

I don't think President Trump losing is bad for the economy since I do think the budget is a mess and trade policy is silly. What I know is that people will trade their perceptions, and more importantly, corporations and the wealthy will trade the tax code.

By The Way, Valuations Matter

For those not familiar with stock market valuations historically, I point you to dShort over at Advisor Perspectives. His team updates a good number of financial and economic charts regularly.

Here's a chart that takes into account several measures of valuation. Virtually every one is near historical highs. We know that rising stock prices are mostly on the back of multiple expansion since earnings are flattish this year and expected to be flattish next year as well.

ValuationsThe Q ratio is the total price of the stock market versus its replacement cost. Why is this important? Well, if it's cheaper to start a business than buy one, that's just what people will do, meaning demand for stocks is set to fall. Q ratio is a favorite of Warren Buffett and could explain why he's sitting on record cash.

2020 Investment Outlook Brief

My prediction for the S&P 500 for 2019 was to end between 3100 and 3200. That's going to be close or spot on. I mention that outlook in several of my webinars if you are following along on YouTube.

Economic growth is not accelerating as promised by politicians and central banks and that's a real problem for earnings. Valuations are extremely high and further expansion of multiples is in doubt. Family offices already are cutting equity allocations, pensions will sell more to finance income payments and another wave of Boomer RMDs is coming, so a correction is coming one way or the other.

For 2020, I see thee S&P 500 getting to the middle 3000s. I don't really know where. My technical analysis a few years ago worked out to a market top of 3500-3600 before a cyclical bear market. So, I'll go with that as the high for the year. Likely in Q2.

I believe a second half correction will happen no matter what. It could accelerate much like it did in 2018 if President Trump loses. I believe that 2020 ends with an S&P 500 around 2200 to 2400 in this scenario.

If President Trump wins, 2020 ends about where it began with volatility in between. We return to blowing debt-driven bubbles and we await the reckoning of an unfunded Boomer retirement crisis that's inevitable.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I own a Registered Investment Advisor, but publish separately from that entity for self-directed investors. See relevant terms and disclaimers at the website of Bluemound Asset Management, LLC. Any information, opinions, research or thoughts presented are not specific advice as I do not have full knowledge of your circumstances. All investors ought to take special care to consider risk, as all investments carry the potential for loss. Consulting an investment advisor might be in your best interest before proceeding on any trade or investment.