SHU is positioning mostly in small-cap technology plays plus some turnaround stories which have their own dynamics and little correlation with market averages.
The greatest risk for the market is the infection of the economy by secular stagnation and the slow demise of the domestic and international institutions that underpin prosperity and democracy.
No dramatic Fed movements or yield curve developments for the year are expected, but this is always subject to change of course.
1) What do you expect to be the key driver of stock market performance over the course of 2020? If you focus on a specific asset class, please address that e.g., what will be the key driver of oil?
For me, earning prospects are always the main focus but for market averages, the economy, interest rates and the election will also play a role. I'm not too focused on that as, despite being a macro-economist by training, I'm really a bottom-up investor fishing largely in the small-cap technology universe where market averages and macro concerns, while not completely irrelevant, tend to matter less.
2) As we begin 2020, are you bullish or bearish on U.S. stocks/your preferred asset class?
I have an optimism bias simply because the asset class (small technology stocks and a few turnaround situations) I mostly follow tend to consist of stocks with their own growth dynamics.
Take for instance Par Technology (PAR), which is driven by their excellent Brink POS software platform which is signing up new restaurant chains, with better pricing and, through innovation, acquisition and partnering, getting a bigger slice of the customer spend.
Or take Roku (ROKU), Trade Desk (TTD) and Telaria (TLRA), largely driven by cord-cutting and explosion in CTV advertising. Or Inseego (INSG) riding the 5G wave, these things have their own momentum which might be going a little slower or faster depending on the state of the economy, but not by much.
3) Which domestic/global issue is most likely to adversely affect U.S. markets in the coming year?
The risk that secular stagnation will start to infect the US as well and we have to rely on ever more fiscal and/or monetary stimulus. Investment, both public and private have been on a downward path for decades, combined with adverse demographics, a concentration of economic gains at the top and high debt levels and you have a recipe for slow growth and low or negative interest rates which has infected much of the developed world.
The US has been able to escape much of this as it is well represented in dynamic sectors and has more favorable demographics compared to many other advanced countries, but whether it can escape these forces entirely remains to be seen.
4) How does the political climate affect the risks and opportunities for next year?
So far it hasn't, but the potential is certainly there and it's something I'm keeping a rather wary eye on. One hopes there is some restraint. The trade war with China has had a substantial negative effect on global trade and manufacturing and I can't see what the gains were, to be honest.
As it was producing negative economic effects it threatened to affect electoral prospects, so it's been walked back. That might not happen with the next situation.
5) 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?
There are two opposing forces. On the one hand, the world economy is still decelerating with trade and manufacturing stagnant and there is under-investment and a significant savings glut and the main central banks are very accommodating. Basically the secular stagnation I mentioned above.
But on the other hand, US economic growth is still quite good and the labor market getting tight and the budget deficit is large for this time of the cycle, indicating substantial fiscal stimulus.
What will give first? Really hard to say. I think in the short term they're evenly balanced so I don't expect much fireworks from the bond markets.
These things used to be easier in past decades where at a certain point inflation prospects started to increase and the central banks tightened, leading to a recession. That world seems long gone with labor bargaining power greatly diminished.
This already prolongs the economic cycle and then a substantial amount of fiscal expansion was added in 2017 but how long it can go on, nobody really knows.
Rather than rising wages and inflation, the prolonged business is liable to accumulate much nastier stuff like sky-high leverage and complex financial instruments that hide risk, like we experienced a decade ago. But should central banks tighten in the face of credit risks and/or asset bubbles? I think that's the wrong approach.
That's basically saying the Fed should slow the economy even in the absence of inflationary pressures because Wall Street can't contain itself. Rather than use such broad-based instrument that will produce a lot of collateral damage, central banks should target these financial excesses at source and prevent them from getting out of control in the first place.
6) In terms of asset allocation, how are you positioned as we begin the New Year?
Stocks, mostly small-cap tech stuff where you can spread the risk and hopefully have a few multi-baggers (like Roku, Trade Desk and Inseego), which afford you to increase the number of interesting but risky plays. It's a bottom-up approach.
7) What ‘surprise’ do you see in the market that isn’t currently getting sufficient investor attention?
The hollowing out of institutions, both domestically and on an international level. I can wholeheartedly recommend a reading of Daren Acemoglu and James Robinson's Why Nations Fail, explaining the importance of institutions.
Nations thrive when they develop inclusive political and economic institutions, and they fail when those institutions become extractive, concentrating power and opportunity in the hands of only a few.
Most of our prosperity and democracy are based on these but we tend to take these for granted. I advise everyone to read Anne Appelbaum's article in The Atlantic describing how easily Poland glided into authoritarianism even without any economic crisis or immigration problems. David Frum had similar warnings a few years earlier and a decade and a half earlier there was of course Fareed Zakaria's The Future of Freedom on the rise of illiberal democracy.
While globalization has a bad rep, the alternative is almost certainly much worse and the experience from some smaller countries in the North of Europe shows that countries can thrive in a globalized world without leaving those who lose out to their own devices but giving them new perspectives instead.
How globalization impacts an economy is largely a domestic policy issue. You don't see many rust belts, deaths of despair or declining life expectancy in the likes of Netherlands, Denmark or Sweden, despite the fact that these countries are much more open and dependent on trade and the global economy compared to the US.
International institutions like the WTO, NATO, and the EU are under attack as well. The EU made a horrendous mistake with the euro, but otherwise it has been beneficial for business. Intra-EU trade has grown faster and much of the supposedly business killing regulation is in service of creating a level playing field for companies, underpinning the Single Market.
The latter is an economic success story that has gotten little attention. There is an interesting difference emerging with the EU being more pro-market versus the US being more pro-business. These concepts are often conflated but are really quite different, resulting in many goods and services that used to be cheaper in the US two decades ago, are now more expensive compared to their EU counterparts.
We might also see something of a reversal of the belief that markets can solve everything. While the state can certainly be overbearing, research shows that it's the quality (rather than the size) of the state that makes an economic difference.
For instance, we tend to forget that most of the technology which has made many of the big tech and many pharma companies rich came out of public R&D efforts or finance. This source of wealth creation has shriveled. I'm with the ex-chief economist of the IMF Simon Johnson who pleas for a renewed effort here.
8) What role will the Fed play in the coming year?
They are accommodating, which is not uncommon in an election year. This isn't without risk, inflation is creeping up and investment isn't really growing. Nobody knows how tight the labor market really is, not even the Fed. Since these are full of people who are smarter than me and have access to more data, I'm not going to pretend that I know.
9) What issue is receiving too much investor attention and/or is already priced in?
I was inclined to say headlines, but the markets have been pretty well-behaved despite the increase in Middle East tensions. On the other hand, there are headlines pointing to developments that have serious implications for certain asset classes, rather than the markets in general.
Obviously, the present Middle East tension tends to be good for oil, gold and defense stocks, and there were victims from the trade war which, if it had escalated, could have had more serious effects on the economy.
Moreover, the results of the US election are going to have a serious effect on some sectors of the economy, like alternative energy, for profit education and, to a lesser extent, healthcare. While I'm very interested in these developments from a macro perspective, it rarely affects my bottom-up investment approach or selection.
Disclosure: I am/we are long INSG, TTD, ROKU, TLRA, PAR. 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.