As with many other market observers, Seeking Alpha contributing veteran Eric Parnell says the upcoming elections and Fed actions will likely drive stock market action.
In this installment of the 2020 Outlook series, Parnell says he's "moderately bullish" on U.S. stocks this year. However, beyond 2020, some challenges may surface. And what may adversely impact market activity in 2020? Parnell offers one word: China.
What do you expect to be the key driver of stock market performance over the course of 2020?
Two primary forces are likely to drive stock prices in 2020. The first is the upcoming elections in the U.S. The second is the actions of the Federal Reserve.
I miss the days when the answer to this question was more fundamental like corporate earnings, valuations, and/or the U.S. economic outlook. But such is not the environment that investors have operated for many years now.
As we begin 2020, are you bullish or bearish on U.S. stocks?
I'm modestly bullish on U.S. stocks for the upcoming year in 2020. Longer term, I am definitively bearish, but these are challenges that are not likely to surface until 2021 at the earliest. Moreover, this modest bullishness comes despite the fact that I think corporate earnings growth is likely to fall flat if not turn negative and stock volatility is likely to increase.
The fact remains that we remain in a stock market environment where fiscal and monetary liquidity continues to flow, banks remain willing to lend, and U.S. economic growth continues to chug along, all of which is likely enough to drive low to mid-single digit positive returns on the S&P 500 Index in the coming year.
Indeed, stocks are expensive with valuations on a number of metrics at or near historical peaks. But valuation typically does not matter to investors until it suddenly matters a lot (in a negative way, of course). And we are not at a juncture where it's ready to matter quite yet. And as long as liquidity continues to flow, stocks should be able to maintain these premium valuations if not modestly expand on them even further in the coming year.
With all of this being said, I'm modestly more constructive on the prospects for long-term U.S. Treasuries and precious metals such as gold and silver heading into 2020 than I am on U.S. stocks. All can gain in 2020, but I'm anticipating that long-term Treasuries and precious metals may end up advancing more in the upcoming year than the U.S. stock market as a whole.
Which global issue is most likely to adversely affect U.S. markets in the coming year?
One word: China. I'm not saying it will adversely affect U.S. markets in the coming year, but it remains arguably one of the biggest and least talked about downside risks that may adversely affect the U.S. markets heading into any given year in the post-crisis period.
Remember the so-called "taper tantrum" in 2013? The flash crash in August 2015? The sharp spike in U.S. bond yields after the U.S. election in 2016? A closer investigation into all three of these past market episodes finds that China resides at the heart of each one.
Today, the Chinese government is once again making moves with the intent of curbing financial excess. In the past such as 2013 and 2015, these actions have resulted in liquidity shocks that spilled over into U.S. markets. While it may happen without incidence in 2020, the downside risk of a reoccurrence cannot be ruled out either.
How does the political climate affect the risks and opportunities for next year?
The political climate matters immensely in terms of risks and opportunities for 2020. We are entering into the heat of the U.S. presidential election season in the months ahead. And one of the two main participants in this race is the incumbent president of the United States, who actively touts the stock market as a reflection of the performance of his administration in its first term.
As a result, investors should anticipate policies out of the executive branch that are supportive of stock prices. Conversely, investors should also anticipate an active fiscal response where applicable along with vocal rhetoric and heavy pressure directed at the Federal Reserve in the event that the U.S. stock market experiences any strong short-term downside volatility along the way. It's not as though the Fed has ever been shy throughout the post-crisis period about responding at a moment's notice at the first signs of any sustained stock market weakness anyway, so investors should also expect Federal Reserve policy makers to respond with additional rate cuts and balance sheet expansion under any such scenario even though it's a presidential election year.
What about impeachment and other geopolitical risks such as potential war in the Middle East? While these events may be important and newsworthy throughout the upcoming year, they do not present any meaningful downside risk to the U.S. stock market outside of some intraday price volatility. History has repeatedly shown that stocks simply do not care about such matters for any sustained amount of time. As long as the liquidity is flowing, U.S. stocks have the ability to continue rolling along.
What do you expect out of the yield curve in 2020, and what impact will that have on the equity market and the economy in general?
The yield curve still matters, but not nearly the way that it has in the past. This isn't one of those "this time is different" statements. Instead, it reflects the reality that interest rates across the U.S. Treasury yield curve are now so distorted because of the hyperactive monetary policy that has taken place for so many years now during the post-crisis period. It's true here in the U.S., and it's even more so true in many developed nations across the world.
How else can we make sense of the fact that the yield on the 50-year Switzerland government bond is a negative -0.19%? Let me put it another way. I'm going to borrow money from you, and you're going to pay me for borrowing money from you at a rate of $19 per year for every $10,000 you give me. Deal? Yeah, I didn't think so. I think historians and scholars in some future decade will reflect back on our current period of negative interest rates and egregious moral hazard and have a field day teaching those lectures. Until then...
With all of that being said, the U.S. is one of the only places left in the prime rated sovereign world that's offering any kind of measurable yield on its debt, but the fact that the Fed threw in the towel last July by starting to lower interest rates despite our "booming" economy suggests it's only a matter of time before we join the rest of the world with our Treasury yield curve pinned to the zero bound. This implies a heck of an attractive total return opportunity on long-term U.S. Treasury bonds along the way despite already low rates.
In terms of asset allocation, how are you positioned as we begin the New Year?
Here is a peak behind my Marketplace kimono (shameless plug, I know).
35% U.S. stocks
8% Preferred stocks (investment grade, non-callable)
7% Precious metals
6% Currency hedge
10% Long-Term U.S. Treasuries
6% U.S. TIPS
4% Taxable Municipal Bonds
5% Managed Futures
19% Cash and Cash Equivalents
These are target allocations that I have had largely in place unchanged for the last 18 months to two years now. But it's likely that these allocations will start to shift, potentially measurably, as we progress through 2020.
What "surprise" do you see in the market that isn't currently getting sufficient investor attention?
Beyond the previously mentioned China, other potential "surprises" include the following:
The U.S. economy falling toward recession in the second half of 2020 or early 2021.
A sudden and unexpected tightening of liquidity conditions for any number of reasons.
The widening of credit spreads, particularly among BBBs and high yield. The senior loan market also has long been a potential accident waiting to happen. "Cov lite" or effectively "Cov nada" loans anyone? As long as the yield is right, right? But for how long.
The unpleasant awakening to the reality that there's simply not enough Millennials in the galaxy to fill all of the bougie apartment units that are going up like weeds in and around so many major metropolitan areas across this country. Not so good for commercial real estate prospects going forward.
Waking up to the fact that the growing number of far right and far left political candidates that are making their way into key leadership roles around the globe do not have "furthering the wealth inequality of the top 1% by bending over backward to make stock prices go higher" at the top of their policy agenda. At some point, the music is going to stop and the farcical "wealth effect" charade is going to end. Exactly when markets wake up to this looming reality remains to be seen.
What role will the Fed play in the coming year?
My prediction. The Fed will talk all tough about how they're going to stay on hold with interest rates and not cut them in 2020. They may even muse about potentially raising rates in 2020 (Gasp! Double gasp! How brave for monetary policy makers to even consider the thought in today's "stellar" U.S. economy?). But then a butterfly will flap its wings outside of the New York Stock Exchange, stocks will fall between -9% and -12% over the course of four to five weeks, and the Fed will start talking about how it's considering easing monetary policy despite the fact that the underlying economic data really hasn't changed.
Why do I make this prediction? Because I've seen this script play out year after year since the outbreak of the financial crisis. It's a really old and really tired script, but it's the one we're still seeing. Interest rates are at best staying flat, they are likely going lower, the Fed balance sheet is likely to expand even further, and all of this is supportive of stock prices, bond prices, and precious metals prices, at least for much of 2020.
What issue is receiving too much investor attention and/or is already priced in?
The U.S. economy and corporate earnings. Both of these were priced into the S&P 500 Index about 1500 S&P points ago, but they still get talked about daily in the financial news media as if they fundamentally matter at this point. The only time they will really matter is when corporate earnings growth starts falling (a more imminent risk) or more significantly when the U.S. economy falls into recession (further out on the horizon at this point). The latter is particularly important because this is where the vitally important buybacks sidewalk ends for U.S. stocks. But in the meantime, both largely ceased to matter from a fundamental perspective many moons ago now.
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Disclosure: I am/we are long USMV, PSLV, TLT, PHYS, PSLV. 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 am long selected individual stocks as part of a broad asset allocation strategy.