Seeking Alpha

DoctoRx Positions For 2020: The Fed And The Trend Are My Friends

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About: SPDR S&P 500 Trust ETF (SPY), Includes: DDM, DIA, DOG, DXD, EEH, EPS, EQL, FEX, HUSV, IVV, IWL, IWM, JHML, JKD, MSFT, NEE, OTPIX, PSQ, QID, QLD, QQEW, QQQ, QQQE, QQXT, RSP, RWM, RYARX, RYRSX, SCAP, SCHX, SDOW, SDS, SH, SMLL, SPDN, SPLX, SPUU, SPXE, SPXL, SPXN, SPXS, SPXT, SPXU, SPXV, SQQQ, SRTY, SSO, SYE, TNA, TQQQ, TSLA, TWM, TZA, UDOW, UDPIX, UPRO, URTY, UWM, VFINX, VOO, VTWO, VV, WFIVX
by: DoctoRx
DoctoRx
Special situations, growth at reasonable price, value, micro-cap
Summary

The Fed's about-face last year, from very tight money to rate cuts and reinfusion of new dollars into the markets, keeps me bullish on stocks.

Equity valuations are iffy, but in relation to bonds and cash, I find them acceptable.

I am mostly sticking with quality given some froth in some very highly valued smaller names, and with diversification toward income and value.

Part of my bullishness on stocks, and on healthcare stocks in particular, comes from assessing Trump's reelection odds as higher than the markets are pricing in.

But, I continue to see the Fed and not politics as the main driver of market performance in 2020, with the many unknowns also to contribute unpredictably.

Introduction

Seeking Alpha sent me the following questions last week, to which the following represent my current thinking. Please feel free to share your thoughts in the Comments thread.

Note: This was submitted for editorial review Sunday, Jan. 5. Views, positions, and all else is valid as of then.

A happy, healthy and prosperous New Year to all!

What do you expect to be the key driver of stock market performance over the course of 2020?

The most predictable key driver of equity performance will likely be the Federal Reserve, as usual.

Recent market history supports the concept that the Fed is the market's most important swing factor. For example, take recent history.

Stocks (SPY) decelerated and then headed down sharply in the second half of 2018 when the Fed reduced its basic money supply. This rate of monetary shrinkage rose to $40 billion per month in the third quarter of 2018, then to $50 billion per month in October. At the same time, the Fed continued to increase interest rates. At the rate of monetary shrinkage of $50 billion per month, or $600 billion per year, the Fed was reducing the country's basic money supply by more than commercial banks were creating new credit via loans and leases. No wonder the SPY dropped 20.3% from its high to its December low, while the broader Wilshire 5000 (WFIVX) dropped 23%.

The rally began when the Fed took its foot off the interest rate brake. Then the recovery rally headed for new highs over the past few months when the Fed completely reversed its tightening policy and began pumping right back into the economy the same money it had continued to remove up until July 2019.

If the Fed continues its recent pro-growth policies, I expect the broad market to perform well, all else being equal. If the Fed reverts to its oft-failed stop-go policies, look out below.

Monetary policy is not everything in the markets, of course. Some other factors will drive market performance and be seen as key. But right now, I cannot predict what it or they will be. Thus, I point to the Fed as my main response to this question.

As we begin 2020, are you bullish or bearish on U.S. stocks?

US stocks are indeed my preferred asset class. I am near maximal bullishness at this time, though valuation is an issue.

Which domestic/global issue is most likely to adversely affect U.S. markets in the coming year?

Shortage of skilled labor is the leading domestic issue I foresee for the markets. This both restrains growth and compresses profit margins.

Globally, based just on the news of the last several days, it would be reasonable to point to the most worrisome and important global issue as being the Middle East. However, recency bias needs to be guarded against. So, being somewhat optimistic about the Mideast, my candidate for the most likely adverse global issue is a global economy that does not accelerate as usual out of its slowdown/recession.

How does the political climate affect the risks and opportunities for next year?

The markets are underestimating Donald Trump's reelection odds, and since Mr. Market has been voting for Trump since the morning after his election, this provides upside potential to the stock market that is not fully priced in.

For example, the PredictIt website shows it costs 48 cents to bet on Trump winning and 2 cents to bet on Pence winning in November, suggesting 50-50 odds is a reasonable approximation (data as of Jan. 4).

Brief rationale for thinking that the approximate 50-50 odds of the Republicans retaining the White House (similar to the odds of Trump being reelected):

1. Beginning with the 1896 election, an election has led to the White House switching from Democratic to Republican, or Republican to Democratic, 12 times through the election of Barack Obama in 2008. Of those, only one of the 12 resulted in a switch back to the party just ousted in the next election; that was the four-year Democratic control of the White House under Jimmy Carter's presidency. So, precedent always favors the incumbent.

2. Incumbents who have a reasonable claim to both peace and prosperity should be favored. Even just one of the two of them has often been good enough. In cases where the president is retained but the electorate has reservations or significant disagreements with him, the pattern since the 1950s has been to put at least one house of Congress - typically the House of Representatives - in opposition.

Obviously, there's lots of time for things to change, but playing the White House to remain in Republican control is the main domestic political consideration I'm factoring into my strategy for this year.

What do you expect out of the yield curve in 2020, and what impacts will that have on the equity market and the economy in general?

I am watching the yield curve closely. I think it is still too flat for comfort out to five years. Even the 2-10 spread at 27 basis points at Friday, Jan. 3's close is very low. A research piece from the San Francisco Fed a few years ago noted that a 2-10 spread below 30-35 basis points warned of recession. But: Whether these numerical spreads remain relevant in our era of ultra-low interest rates is unknown.

A current Bloomberg News article is titled "Fed Officials Saw Rates on Hold, With an Eye on Downside Risk," so I think that finally the Fed is being realistic. Perhaps it is willing to engage in another rate cut or two soon as a precautionary measure against a deeper slump as well as to weaken the U.S. dollar, which would stimulate export growth.

All this is generally more good than bad for equity market performance, though of course an actual recession would almost certainly delay a bull move in stocks and would also markedly up the odds of a Democrat winning the White House in November.

In terms of asset allocation, how are you positioned as we begin the New Year?

As of Jan. 3, I am almost 50% allocated to stocks, which is close to maximal ever since I scaled mostly out of the market in Y2K. I am about 3% in gold and about 3% in cash. The rest is in bonds.

The stock and bond portfolios are more diverse than ever in my 40-plus years in the markets. My stocks range from small speculative growth stocks to globe-girdling mega-caps and now include REITs as well as utilities. Microsoft (MSFT) is by far my No. 1 stock, at 15% of equity value. NextEra Energy (NEE) is second-largest. I wrote my first MSFT article in May 2018, and my first NEE article in August 2018; both were unequivocally bullish.

Absent from my portfolio are oil and gas producers, consumer staples names, and automobile manufacturers other than Tesla (TSLA).

Last week, as the Fear & Greed Index spiked to 95 and above, I began taking profits somewhat aggressively on several very high P/E (or infinite P/E where earnings are negative) stocks. I began tilting more toward value while adding just a bit more cash reserves. I expect the tilt to value is a durable trend but that the modest amounts of extra cash will be deployed soon without trying to do any major market timing.

What "surprise" do you see in the market that isn’t currently getting sufficient investor attention? Here are four potential surprises (not predictions):

1. Trump's acknowledged odds of reelection rise, which would tend to be good for equities in general and healthcare stocks in particular.

2. The Fed cuts rates in the first quarter even without a clear recessionary series of data dumps, which would be bullish.

3. Crude oil/gasoline prices drop as 2020 moves along, which would be bullish.

4. Growth stock P/E figures return to earth from outer space, which would be bearish for the affected stocks. However, if this occurred without a recession, I believe it would be bullish for value stocks.

What role will the Fed play in the coming year?

Key, as usual; see my response to the first question.

What issue is receiving too much investor attention or is already priced in?

I do not see any right now worth mentioning. (This statement excludes the recent headline news regarding Iran, where it is simply too soon to say if it is receiving "too much" investor attention.)

Disclosure: I am/we are long SPY,MSFT,NEE,TSLA. 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: Not investment advice. I am not an investment adviser.