Review of 2019 and look ahead to 2020
2019 was a buoyant year for most equity and fixed income markets perhaps surprisingly actually given the mood at the beginning of the year, but what were the main drivers of this success?
Well firstly let's look at 2019. In terms of the performance global equities were up 27% and you wouldn’t have guessed that if you looked at the earnings because earnings steadily decelerated throughout that year, and in fact there was virtually no earnings growth at all in 2019. The key driver was the Federal Reserve and other major central banks by loosening in terms of interest rates by increasing the size of their balance sheets and reversing the tightening policies that we saw at the back end of 2018. These were the key market drivers going into 2019 plus it's also worth bearing in mind that the trade protections and rhetoric that started off in 2018 and continued into early 2019, towards the back end of 2019 we saw President Trump has dialled back some of that trade protection rhetoric and indeed we might get a trade deal signed with China, at least the first phase, sometime this month.
Okay and as we're looking forward to 2020 we've had a ten-year bull run in equity markets and fixed income markets have been very strong as well, it raises the bar somewhat for performance in the year ahead so what are your sort of big picture thoughts on the year. I mean particularly things like a trade war and whether a recession is likely?
Well again I think you have to look back in the last ten years. I mean the key outperforming equity market has being the US. It has simply out performed all other markets put together and for the U.S. to continue to outperform in this next decade it's going to be pretty difficult, also considering that its valuations are at a premium compared to the other markets. So this is where we have to look at the other markets and I think this year we should start to see a catch up in the rest of the world and particularly markets like the UK for example, Europe and Japan and the emerging markets and that's simply because that the economic growth premium that the US had over the rest of the world is disappearing. So for example I'll give you some numbers if you looked at nominal GDP in the U.S. it grew by 4% per annum throughout the last decade as against 2.7% for example for the rest of the world. That's likely to be dissipated to virtually nothing in terms of the outlook over the next couple of years and I think when we look back at this we can see that it's the economic growth from the rest of the world that catches up to the U.S. that's going to be driving the earnings in these countries, so much so that we probably expect higher earnings growth in rest of the world over the US and that's why we'd like the rest of the world relatively to the US.
I guess the US has also been driven by these big tech stocks, you know Apple, so huge share price appreciation in 2019 despite relatively lacklustre earnings growth and that seems to be a function of a lot of passive money, I mean, that should correct as well?
Well again looking at what was driving that, all roads lead to the Federal Reserve again. When we had turning points in terms of policy coming from the Fed, when it starts to become more dovish, this was at the start of January, in the middle of June ahead of interest rate cuts at the end of July and also on the 11th of October when they start to buy $60 billion a month in t-bill purchases. That's when a lot of the gains were made for these so-called FAAMG stocks. Just for the listeners when we talk about the FAAMGs we're talking about Facebook Apple Amazon Microsoft and Google. That's when they made their big gains is when there was changing in terms of policy coming from the Fed and looking forward are we likely to see the Fed becoming just as dovish, probably that they'll keep rates on hold and in terms of their asset purchases unlikely to incrementally increase them unless there's a real sharp downturn in growth. So I think given that we've had this low-hanging fruit where the FAAMG made big gains in 2019 to expect them to make other big gains in 2020 is a very high bar to ask.
And just to be clear you're not expecting any big deceleration in US growth or expecting them to avoid recession?
No our base case is that the US continues to motor on around 2% real GDP growth so we're still far away from a recession but I think that just some of these FAAMG stocks have run very hard so it might be much more prudent in terms of asset allocation to move a little bit away from these stocks who have done very very well, while valuations have got a bit more rich and moved to countries like the rest of the world where we think that actually there's room for them to catch up to the growth rate of the US.
Okay and I mean you mentioned the UK and we have a shiny new government depending on your view but at least you know a definitive majority and a way forward do you think there are opportunities there I mean the UK has been very unloved?
Yes I mean I think the key turning point in the UK was obviously the 13th of December when we had the election results and that's when they ended the risk that would get a far left labour led government under Jeremy Corbyn. So now we have the next five years which is like to be Tory unless there is a shortened government there and that takes away that risk or the discount that was placed in UK valuations where overseas where investors were concerned about the left-wing policies coming from Labour. Now what does that mean for the UK well it's constructive because all of that pent-up demand that was there before the election is now likely to come through and through that rising confidence that we'd expect from businesses and also consumers we think that that's going to be a very important driver of domestic growth. On top of that we'll get a clearer message from the government on the 11th of March when Chancellor Javid will present his first budget and within that we'd probably expect to see much more government spending particularly up north potentially even having some stamp duty cuts to revive the property market or raising thresholds, but either way we are likely to see an improving growth prospect in the UK so that means the UK in terms of some of the domestic stocks which have been bombed out because the concerns about Corbyn and domestic growth are likely to get some new life. I would expect the domestic stocks in the UK to outperform their international peers.
Ok, what about Europe? I mean obviously the UK has some pretty tricky negotiations ahead with Europe and in the meantime the eurozone economy has been pretty dismal for much of the year as well but the economy and the stock market are not the same thing so do you see any opportunities there?
Yeah I think if you were to look at a mirror image of growth eurozone is likely to grow much more strongly than it did in 2019. Remember in 2019 the Eurozone was affected quite severely by the trade protections and rhetoric coming from President Trump and that affected big exporting powerhouses like Germany which dragged down the overall eurozone growth. In that time period we've seen increasing stimulus coming from the ECB and that's led to a big pickup in lead indicators like narrow money supply growth and what we think is that tends to lead economic growth so provided President Trump doesn't double down on trade protections and rhetoric and go off to say for example the European auto manufacturers we think that we should start to see not quite a v-shaped recovery in growth but certainly a pickup in growth and more for a growth pickup with the US.
OK president Trump has an election to win though?
Yeah I think trying to predict what president Trump will do is obviously a fool's game but for him the last thing he wants is in a presidential election year is to introduce any sort of policies and trade protectionism that could undermine his chance of getting re-elected and indeed we've seen some of the key states he needs to win like Ohio Wisconsin Pennsylvania or Michigan, these states been affected by some of the sanctions that the Chinese have done. For example, they introduced policies that would go off to some of the soybean farmers in Wisconsin and some of the auto companies in Michigan, so it makes sense for president Trump not to double down on trade protectionism and actually rollback indeed that seems to be where we're moving towards.
Yeah okay now the other area that you talked about in investment outlook was global emerging markets these have been surprisingly unloved you'd have thought because there's still some decent growth coming out of specific emerging markets anyway what are you seeing there?
Yes it's worth looking back in 2019 emerging markets and we're really talking about Asia which is the bulk of emerging markets were hit by a double whammy, one was the trade protections and rhetoric and two was the unrest we saw in Hong Kong. Looking forward as we said our base case view is that the trade protection rhetoric from President Trump would be dialled down, the protesters in Hong Kong that's another unknown but what we can say fundamentally is if we look at the earnings growth by the consensus they expect earnings growth of 15 percent for emerging markets as a whole that's the highest of all the other major regions. The other key positive or tailwind for emerging markets would be that if the dollar starts to weaken which is our base case view judging by the fact that the current account deficit still remains wide and it's widening in the US we think that any dollar downside will give a fillip for emerging market equities they tend to move inverse to each other and if that's the case then emerging markets after underperforming other developed markets last year it could be the outperformers this year.
Okay great thank you for those insights into 2020 that concludes our episode today Thank You Daniel and also thank you to our listeners for tuning in and all references and links we've talked about in this episode can be found in the episode show notes. Subscribe to our show if you haven't done so already and races review us in the App Store until next time.
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This episode was recorded on 27/01/2020
This S&W The Pulse podcast is of a general nature and is not a substitute for professional advice. No responsibility can be accepted for the consequences of any action taken or refrained from as a result of what is said. The views expressed are not necessarily those of the presenter or of Smith & Williamson or any of its affiliates. No reproduction of this podcast may be made in whole or in part for professional or recreational purposes. No action should be taken based on this podcast and we accept no liability if we change your views on any of the subjects mentioned.
Please remember the value of investments and the income from them can fall as well as rise and investors may not receive back the original amount invested. Past performance is not a guide to future performance.
The Pulse from Smith & Williamson
Investment Show: Review of 2019 and look ahead to 2020
Broadcast on Smith & Williamson at 09:00, 27th of Janaury 2020
Available online from 10:00 on the same day .