“The More Things Change….”
2020…..wow, I’m getting old. And since I don’t want to become too much of an old curmudgeon, I’m going to skip the annual sarcasm about these industry-wide outlooks. No sarcasm. No skepticism. No anger. Only positive vibes. I can do this……
Jumping right in, and to hold ourselves accountable, let’s take a look back at last year’s outlook to see how we fared – beginning with the annual “Round Hill vs The Coin Toss” competition measuring which was better at predicting 2019 in terms of markets and interest rates:
Up > 10%, but < 20%
Up > 10%, but < 20%
10 Year Treasury Yield:
Yeah, that’s right – your financial advisors are in fact more intelligent than your average, run-of-the-mill coin….at least by a small amount. Unfortunately (or fortunately in this case), neither were clairvoyant enough to see the massive run in equities or equally massive decline in interest rates – but plenty on that later. Let’s revisit the reasoning behind our thoughts heading into 2019 (the coin can fend for itself):
We interpret the latest Fed-speak as confirmation that their fear of disrupting Wall Street outweighs any other data they may choose to consider. As such, we find it highly unlikely that the Fed will raise rates even once during 2019. In our opinion, not a single other factor – technical or otherwise – outweighs what the Fed says and does. This was proven repeatedly over the past decade, and once again only last year.
The Donald has gone from calling the stock market a “fed-induced, crazy bubble” while he was running for President, to making it his primary measuring-stick of success once he took office. It is our belief that recent volatility in the markets – coupled with the new Congress and all of the mindless investigations sure to follow – make it highly likely that Trump will want a trade deal with China in the very near future. Trade relations with China remain one of (if not THE) biggest uncertainties affecting stocks. A resolution to this dispute would almost certainly be met with optimism by markets – and Trump desperately needs the markets at the moment.
We are not sure what to make of the recent plummet in rates – but we are convinced that next year’s outlook will read “the 10-year told us what was coming”. The move down from 3.1% to current levels was curious, though hardly inexplicable with the S&P 500 dropping some 20% at the same time. What is perplexing is the fact they have not rebounded at all since stocks reversed course. While the S&P has recovered nearly 10% from its bottom last year, rates on 10-year treasuries actually declined. On one hand, this could very simply be realization that the Fed is no longer a concern. On the other, rates could be signaling that this recent reversal off the bottom for stocks was nothing more than a “dead cat bounce”, and we should expect more troubles ahead. We are ever-so-cautiously assuming the former, at least as of this writing.
There seems to be no end in sight for the record levels of stock buy-backs. This certainly provides the market some level of protection, although to what extent has never been (nor could it be) proven. At the very least, it provides some level of demand for stocks.
It is for all of these reasons that our outlook is cautiously optimistic for both stocks and bonds in 2019. We predict that the Fed will follow through on their more dovish comments of late, and keep interest rates in check. That will keep the “free-money party” rocking for stocks – and buy-backs coupled with a resolution to trade disputes with China will serve as reinforcement booze that might just turn this thing into an all-out rage.
Now we also predicated the above by saying we wished we had 3 more weeks before publishing, as we would likely be much more convicted one way or the other. That was in fact the case as the Fed doubled down shortly thereafter and started talk of lowering rates in 2019. Unemployment at all-time lows, stock market at all-time highs and interest rates still next to nothing. It was laughable that they even mentioned it – I literally laughed out loud when I heard it the first time….
The Fed went on to cut rates not once, not twice, but three times during the course of the year. Three. Times. You can’t make this stuff up.
(reminds self: no sarcasm, no skepticism, no anger…..)
So, that was all we needed for confirmation that the drastic drop in the 10-year rate toward the end of 2018 was not foreshadowing problems ahead – it was confirmation that the Fed was going to prop these markets ‘til they can’t be propped no more. Which is of course precisely what happened, with the S&P 500 up some 29% as of this writing….
But the truly great news around this development for more conservative (or responsible) investors – at least for the short-term – was what it provided in the form of bond appreciation. We didn’t see that coming in our wildest dreams. I’m still in shock, but thrilled for what it did for our clients and their statements. At least this year. Positive vibes.
As for the trade war with China, we are going to go ahead and take a victory lap on that one as well – although it didn’t look quite the way we anticipated. Instead of any deal being reached (although I guess they are saying that some semblance of one actually has), Trump took the opportunity either himself or through his staff to announce that “a deal was close” just about every other week. Coincidentally or not, the announcements tended to follow whatever few down days the markets experienced. Surely coincidental. No sarcasm. No skepticism. And for those reasons, I’m leaving the buy-backs completely alone this time around. Again, positive vibes.
Before we delve into our outlook for 2020, we want to take some time to examine the overall environment from a longer-term and more historical context. Some of this we have covered in previous writings, but we feel it worthwhile to revisit. In the end, we hope this analysis will help to explain the discrepancies between our outlook for 2020, vs our feelings on the environment overall.
If we could summarize our last 5 years’ worth of quarterly summarizes into one graphical representation, this is what it would look like:
NOTE: Shaded areas above represent periods where US is in recession.
Ok, so let’s go through above illustration chronologically to discuss and examine points of particular interest.
The “Dot Com” era – otherwise known as “The 90s”
To be clear, we do not view the 90s as purely a function of Fed-induced hysteria. The internet was coming into its own (thanks Al!), and there is no question that a “technology revolution” was underway. As a result, a very favorable stock environment is understandable. Of course, as the decade wore on, the stock market became increasingly rampant with speculation on start-up internet companies who we later confirmed were in fact worth nothing….
This is where the Fed comes in to play – and in our view – is the first example of “Fed manipulation” that still runs rampant today. You can see from the illustration that even as the market picked up steam – and the speculation became more rampant – the Fed reversed course on raising interest rates. After a brief yet significant market pullback later in the decade, the Fed actually decides to cut rates for a brief time – and the market reverses back higher. Sound at all familiar?
For those that remember this period, you will remember the immense pressure that then-chair Alan Greenspan was under from Wall Street and politicians alike. Again, in our opinion, this was the first example of a Fed Chair making decisions based more on Wall Street pressure than anything else. Ironically, but to his credit, Greenspan today is one of the more vocal critics of the Fed and their role in creating “bubbles” in asset prices.
The Dot Com Burst
Most of us remember how this period ultimately ended. Once the Fed finally began raising rates again, the markets could take no more. From the height of the market until it finally bottomed, and using round numbers here, the S&P 500 lost approximately 50% of it’s value. That’s a big number.
To make matters worse – and to be fair to the Fed reaction – we often forget that 9/11 also occurred during this “bottoming out” period. This further brought the economy to its knees. The Fed reacted during this period by dropping rates….and fast. Fed Funds rates went from about 6.5% at their height down to about 1% at the bottom. That means the Fed felt it necessary to cut rates by approximately 550 basis points (or 5.5%) to get the economy and markets back on track. Remember this number as we will revisit later on…
My Home, the ATM
The stock market ultimately bottomed in the spring of 2003 – not surprisingly about the same time as the Fed Funds rates. Between 2003 and 2009, the stock market reversed course and eventually got back to “pre-bust” levels – a return of approximately 100% from the bottom. While it seems unfathomable based on recent Fed activity (biting tongue, no skepticism), the Fed actually began raising rates in 2004 and never looked back – raising rates from the low of 1.0% up to approximately 5.25% by 2007.
Of course, we can’t possibly ignore what was happening with a certain other asset class during this time period – that being real estate. As we all remember, real estate prices appreciated at a rate never before thought possible. Anyone could get home loans without having any income. In fact, our politicians assured us that everyone should get loans regardless of income. And why not? Home prices don’t decline in any meaningful fashion. Never have, never will. Disagree? Then Fed Chair Bernanke “disagreed with your premise”. Ok, this is now testing my will. No sarcasm, positive vibes only. Got it.
One might intelligently wonder just how much the historically low interest rates played into the housing frenzy? What followed once again provided answers.
The Great Recession
Unless you want a 100-page outlook, this section is going to be overly simplified and most certainly not a thesis on all of the root causes of said events. What we know is that the housing market did in fact “collapse” in never-before-seen fashion. We later found out that our financial institutions had levered up on real estate in unimaginable fashion – apparently they rejected the same premises that our Fed Chair did (tongue now actually bleeding – positive vibes).
I don’t need to go into any greater detail about this period – you all remember it. But let’s look at some key numbers / facts. The S&P 500 lost over 50% of it’s value from its height to the bottom. In response, the Fed cut interest rates from approximately 5.25% to 0% - a move of 525 basis points (or 5.25%). Again, we will come back to these numbers later.
Interestingly, while the Fed got stopped-out by the number zero in its response – they were clever enough to introduce a new form of rate / market manipulation known now as “QE”. While directly in control of short-term interest rates through their policy, the Fed lacked direct control over longer rates – which affect many things not the least of which being mortgage rates. So, in a power move that undoubtedly turned Greenspan many shades of green with envy – Chairman Bernanke embarked on QE1. Put simply, the Fed “printed money” to purchase fixed income instruments in the open market – thus pushing down longer-term rates that they did not directly control. Genius in its stealth and ability to get Americans to spend even more money that they don’t have, and thus spark the economy and markets all at once!
I think I just bit a chunk off my tongue. No sarcasm, no skepticism. Moving on…..
Much like the last time, the Fed’s manipulation of rates proved successful. After bottoming in the spring of 2009 – along with Fed Funds rate and the inception of QE 1 – the S&P 500 went on to appreciate over 200% between the spring of 2009 and the fall of 2015. Woo doggy! Real estate recovered, though sluggishly at first. The banks - who were largely insolvent due to their lack of risk management – not only survived, but became even bigger. By a lot. The Fed had succeeded.
Of course, something was different this time around. The Fed raised interest rates exactly zero times over this 5-year period. Instead, they chose to go down a different path – implementing QE 2&3 during this time. Yep, you read that right. They didn’t raise rates…..they further manipulated them lower.
2015 arrives, QE has run it’s course – and the Fed finally raises rates….by 0.25%. The markets fall. The Fed stops. By the way, we are now into the Janet Yellin reign of power at this point.
Then it happens. The big, orange, reality TV star known simply as “The Donald” gets elected President of the United States – along with a Republican controlled House and Senate. Massive tax cuts for corporations. Even more money left over to buy-back stock. The stock market rips higher accordingly.
Que character number 4 – as Jerome Powell takes over as Fed Chair, serving at the pleasure of the Donald. He quickly acts on his opportunity to raise rates – all the way to 2.4%. He confidently promises to stay on this course. At this point, the S&P 500 has risen nearly 350% from the bottom in 2009. How could he not?
The stock market wasn’t feeling those same positive vibes as Chairman Powell continued his talk of higher rates. I mean how could this economy and market – which everyone on CNBC told us was not at all “simply a function of Fed manipulation” – handle short-term interest rates at a whopping 2.4%?!
Apparently, it couldn’t (at least the stock market side). The S&P 500 dropped nearly 20% from September of 2018 thru the middle of December. That was the end of the line. The market that had appreciated more than 300% over the course of a decade – with virtually zero economic growth for most of that time – had entered that “bear market territory”. Something had to be done.
Chairman Powell swiftly recognized the folly of his ways, and announced that the Fed was on “no pre-determined course of action”. The market stabilized. He then started talking about the possibility of once again lowering rates. The market ripped higher. If you blinked, you might not even know this ever happened.
Which leads us to what we all just witnessed in 2019. The Fed did in fact cut rates – three separate times – to about 1.50% at the time of this writing. The stock market is seemingly making new, all-time highs on a daily basis. We’ve seen appreciation in bond prices that no one would dream possible, given the interest rates that we started the year with.
Flipping back to our graphical summary of all discussed above, you will note the big red question marks labeling where we stand today. This, of course, represents the whole purpose of these outlooks for the year ahead. But as mentioned earlier, there are multiple ways for us to present our thoughts. On one hand, there is the immediate question we all have as to what 2020 might have in store for us. On the other, there is the truly more important question of what opportunities and risks we are faced with in the grand scheme of things.
Let’s start with the latter. If we have done a proper job of laying out the case above, you likely don’t need me to tell you we think the risks continue to outweigh the potential rewards – at least on the equity side of things. For one, we are currently in the longest economic expansion in our country’s history. Having said that, it is also one of the weakest with the exception of the last few years – so we’re not convinced that the length of the expansion necessarily means recession is imminent.
Of course, as we have spent the vast majority of this outlook discussing so far, it is interest rates and the Fed that pose the greatest risk. If the economy does manage to continue its expansion, it becomes increasingly likely (one would think at least) that the Fed would revert back to raising rates. We need to look back no further than last fall to see how quickly that can affect our markets. And now twice in the past 20 years we have witnessed how drastically markets can be affected should rate increases sustain.
So what happens if and when the economy finally starts to crack next? The Fed has virtually no room to maneuver, due to their insistence on historically low rates - even while the economy strengthened. Remember, they cut approximately 550 basis points after the dot com burst. They cut about 525 basis points – along with QE 1,2 and 3 – in order to save us from the Great Recession. We currently sit at 1.50% on the Fed Funds rate. By my math, that means we have only 150 basis points before zero if the economy were to turn ugly tomorrow….
We adamantly believe that every investor out there should have a full understanding of this concept. We also remain unconvinced that enough do. We would truly enjoy questions, concerns, differing opinions or any type of feedback regarding the topic – so please don’t hesitate to reach out…..
Now, on to our outlook for the year ahead. Before I start babbling, let’s dive into our “Round Hill vs the Coin Toss” exercise for 2020. No offense to the coin of years past, but we are moving to a “number randomizer” online so we can include greater numbers of outcomes. As always, because we view these short-term “predictions” to be so mind-numbingly silly (come on Doug, no skepticism), we will use a range of outcomes rather than specific predictions. The potential outcomes are as follows, both assuming end of 2020:
S&P 500 PERFORMANCE
10 Year Treasury Rate
down > 20%
down > 10%, but < 20%
1.00 – 1.50%
down < 10%
1.50 – 2.00%
up < 10%
2.00 – 2.50%
up > 10%, but < 20%
2.50 – 3.00%
up > 20%
And your official results:
S&P 500 PERFORMANCE
10 Year Treasury Rate
Round Hill Wealth:
up < 10%
1.50 – 2.00%
up > 20%
(I have to admit, this has become my favorite part of these outlooks)
Now I don’t ever like to speak for “the coin”, but it apparently believes that the Fed is going to double down on cutting rates in 2020 – and the stock and bond markets will continue to act accordingly. Hey, based on their inexplicable actions this year, who are we to argue?!
As for our outlook, I wouldn’t blame you for being surprised after reading everything that led up to it. But this really does demonstrate the difference between what might happen in any short-term period, versus the overall environment in which the outcome occurs. Or another way of putting it – markets can stay “irrational” for long periods of time….especially when being manipulated by the Fed.
(Damnit Doug – NO sarcasm! NO skepticism!)
Moving on. Let’s dive into more specifics on our outlook for 2020, and the reasoning behind it:
Not surprisingly, the Fed is by a large margin the most important factor weighing in our short-term thinking. First, the Fed was obviously shell-shocked by the market’s reaction to their last attempt to raise rates. Next, it’s an election year – and the Fed doesn’t like being the focal point of politics. Last but certainly not least, the Fed has the security blanket of “global uncertainty due to trade relations” to fall back on as their reasoning for not wanting to raise rates further. As I hope we have demonstrated well enough by now, a cooperative Fed is good for markets. We doubt – but certainly don’t ignore the possibility – that stocks can continue on the torrid pace of 2019. We are even more confident saying the same for bonds, especially since there isn’t enough interest rate left to drop! We wouldn’t be overly shocked to see bond prices drop slightly in 2020, as rates drift higher solely based on market forces. You know, the way credit markets used to work…. (no sarcasm)
The most common question we get – “how will this election affect my money”? This is also, as you might imagine, my least favorite topic to discuss as I have to cringe and duck at the potential backlash of any response. Said this before and will say it again now – politics affect your money. They affect the economy, and they affect the markets. So, we have to talk about it. I always know that I have done my job well with these updates when our clients “on the right” tell me that I sound like Elizabeth Warren and our clients “on the left" call me a Trump puppet – and you’d be shocked at how many times I hear both!
So, here we go. First and foremost, election years tend to be good for the economy and markets. Not always, but more often than not. This makes sense, given the fact our fearless leaders care about nothing more than their election chances, and a good economy or roaring stock market does more than anything to help the cause. And because the House and Senate are currently split, no one can really do much to sabotage that goal. So, we put this in the positive camp.
However, as we head toward the end of 2020 and into 2021…..
I’m leaving this alone for the time being, as we will undoubtedly be discussing this further as we get into next year. But let’s just say that we view this election as enormously consequential for your money, and likely not for the reasons you think. Of course, if anyone is losing sleep over this (please don’t) – reach out and we can discuss in greater detail.
Stocks – US vs International
We touched on this briefly in our last update, but wanted to share a graphical representation of what we were talking about….
The above chart is showing performance of the S&P500 vs the most widely used index for international stocks. We can clearly see the abnormally wide disparity between the two as we came out of the Great Recession. Also interesting to note that the last time we saw this type of activity was leading into 2000 (the beginning of the dot com burst). If we assume a reversion to the mean, international stocks would have to significantly outperform the US for a period of time. Of course, that means they would either have to “make more” or “lose less” to get there.
Because of the greater historical volatility of international stocks, the overall environment and the current state of many of the international economies - we have decided against over-weighting international exposure for clients at the current time. It remains one of the focal points of our discussions, and certainly something worth monitoring.
Trade Wars with China
As mentioned previously, it is nearly impossible to have an intelligent discussion around this topic – as no one really understands what has actually transpired. Furthermore, though we know that “some level of agreement has recently been reached” – no one even understands what that agreement is, and whether or not it is binding in any way.
What we do know is that certain segments of our economy have already been drastically affected. And for the reasons we described above, there is a ton of uncertainty around the topic. Neither of those statements are ones that the markets particularly enjoy.
We remain in the camp that the current administration will do everything in its power to not let these negotiations derail the economy or markets leading up to the election. When I say everything, I mean everything. That said, “it takes more than two to tango….or something like that”. (one of you amazingly got the Jerky Boyz reference in last year’s outlook – who is going to properly identify the quote above…and wow am I exposing my still infantile sense of humor)
Back to business. We are far from convinced that China is wanting to help get the current administration grab a second term. In fact, our common sense tells us quite the opposite. And so these two drastically different goals lead us to a dangerous game of chicken in the coming year. We are ever-so-cautiously in the camp that Trump’s desire for a second term will thwart everything else. Unfortunately, even if it means giving in at the end of the day.
All of that said, if we look back at the end of next year to see carnage in our markets – we would be shocked if the trade negotiations were not ultimately deemed the cause. In other words, this is by far the biggest downside risk we see for the year ahead…..at least until election day.
And with that, another year in the history books! For those of you who have admitted to skipping right to the last paragraph for the summary:
- We are thrilled with what transpired during the course of the year, at least in terms of how it looked on your statements. At the same time, we do not believe the actions taken by the Fed to get us there were wise ones for the long-term sustainability of our economy or markets.
- We remain cautiously optimistic for the coming year based mainly on a continuously timid Fed, and the fact that it is an election year. Continued stock buybacks and financial engineering by corporations – further assisted by the Fed and not discussed in this outlook for personal health reasons – also add to this outlook. All of that said, we find it highly unlikely that either stocks or bonds can continue their current pace of gains heading into the new year, and would expect any gains to be muted.
- Assuming the Fed does not reverse current course, we view the biggest risk to markets and the economy in the coming year to be an escalation of “trade wars” with China. However, we do not view an escalation as a likely outcome. (famous last words)
- We continue to see significant, longer-term risks to our economy and markets. While the Fed has been successful in “kicking the can down the road” through their policies, we are increasingly worried that the next downturn could prove much more severe due to the self-imposed lack of tools left at their disposal.
- Finally, we do believe that the time horizon on these “longer-term risks” is shortening, and that 2020 may very well prove pivotal in terms of the election and subsequent fiscal / Fed policies resulting from it. This will be discussed in greater detail during the course of next year.
(now get back there and read the other 10 pages slackers!)
In closing, and as always, we can never thank you enough for the trust and confidence you have placed in Round Hill. Wishing you and your families the very best for the holidays, and for 2020!!
President & Wealth Advisor
Principal & Wealth Advisor
The opinions expressed in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.
Statements of forecast are for informational purposes and are not guaranteed to occur. Trends discussed are not guaranteed to continue in the future.
All performance referenced is historical and is no guarantee of future results. Investments mentioned may not be suitable for all investors.
Equity investing involves risk, including loss of principal. No strategy – including tactical allocation strategies - assures success or protects against loss.
Value investments can perform differently from the market as a whole. They can remain undervalued by the market for long periods of time. There is no guarantee that any investment will return to former valuation levels.
Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise and bonds are subject to availability and change in price.
Government bonds and Treasury bills are guaranteed by the US government as to the timely payment of principal and interest and, if held to maturity, offer a fixed rate of return and fixed principal value.
International investing involves special risks such as currency fluctuation and political instability and may not be suitable for all investors. These risks are often heightened for investments in emerging markets.
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