For 2019 YTD:
- SP 500: +28.75%
- Barclays Agg: +8.70%
- Gold (GLD): +14.68%
(Morningstar data)
(Source: @CharlieBillelo’s Twitter feed)
In terms of the SP 500 and the US equity markets, clients are being told to expect still positive but lower returns for the general US equity market in 2020, unlike the wildly positive year we’ve seen in 2019.
It’s not a tough forecast, with the Fed/FOMC expected to remain on hold until the November ’20 Presidential election, and President Trump expected to be reelected. ( President Trump’s impeachment will likely lose steam in the Senate since there just isn’t the votes to needed – 2/3rd’s as I understand it – to find the President guilty and remove him from office.) My own opinion is that President Trump’s impeachment will be very similar to President Clinton’s ordeal, with a strong US economy for both President’s impacting public opinion to the detriment of incumbents. Newt Gingrich and the Republican’s lost badly in the 1998 mid-terms. That’s not a forecast, it’s just that the similarities between the two President’s troubles are striking.
The plan is to tell clients to expect 8% – 12% in 2020, primarily based on the work by Nick Colas and Jessica Rabe at DataTrek Research and their strong work on what SP 500 returns look like following years where the SP 500 is up 25% or more.
Here was this blog’s original post on DataTrek’s research: https://fundamentalis.com/?p=9484
Here is the key summary paragraph on “expected” 2020 returns after +25% years:
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Lots of numbers here, so let’s summarize what we know about how the S&P 500 might perform in 2020 based on the historical data:
- From 1928 – 2018 the average total return for the S&P 500 in the year after a 25% or greater gain is +9.4%. That is modestly lower than the long run averages of 11-13% mentioned earlier.
- On the plus side, the odds of a large loss (10% or greater) in 2020 are low based on the historical record. All but one of the really bad years in the last 9 decades (1931, 2008, 1974, 1930, 2002, 1973, 1941, 2001, 1940, 1957) came after sub 25% gain years. 1937 was the exception, as noted above.
- On a more cautious note, the “win ratio” for years following 25% or greater annual returns is modestly lower than the average. The historical record shows that 65% of follow on years were positive versus a 90-year average of 72%.
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According to this blog, expected 2020 SP 500 earnings growth is projected to be 10%, and that’s been constant the last 6 weeks, with some erosion down from 12% as late as late July ’19. The inverted yield curve and slower economic growth in the middle of 2019 saw analysts curbing their estimates, however, it looks as if the forward SP 500 estimate has bottomed and finally started to turn up.
Thoughts on SP 500 Sectors: (% of market cap)
- Technology: 23%
- Comm Serv: 10.5%
- Hlth Care: 14%
- Financials: 13.2%
- Cons Disc: 9.7%
- Cons Spls: 7.3%
- Industrials: 9.3%
- Real Estate: 2.9%
- Utilities: 3.3%
- Energy: 4.3%
- Basic Mat: 2.2%
Here is what investor don’t realize: of the 11 sectors of the SP 500, owning the top 6 sectors, including Industrials, but not Staples, gets an investor 80% of the SP 500’s market cap, with the remaining 5 sectors being 20% of the SP 500’s market cap. The op 3 sectors alone get an investor 47% of the SP 500 by market cap.
Be mindful of this math, when constructing your portfolios.
Fixed Income:
The basic premise held the last 10 years by this blog has been to expect higher interest rates (i.e. Treasury yields) and that has been flat wrong for this decade. At one point clients held a 10% position in the TBF (inverse Treasury ETF, not levered though) but it was sold in late 2017 in its entirety and never repurchased. Waiting for measurably higher interest rates the last 10 years has been the proverbial “Waiting for Godot”, even though – if you truly believe the core CPI and the deflator measurements – most of the Treasury yield curve, at least out to the 10-yr Treasury – is generating a negative return after inflation.
Think about that.
For 2020, clients will remain overweight credit in core intermediate or “unconstrained” bond funds of BlackRock and Loomis Sayles and at least to start 2020 anyway, will have a 10% – 15% weighting in high yield via the HYG, and some high yield bond funds.
With the Fed likely on hold until after the election, absent some exogenous shock, if this forecast is wrong I would expect higher rates and a better economic environment, so duration is being kept at the shorter end of Barclay’s Aggregate (AGG), which – according to Morningstar – is roughly 5.5 years.
My biggest worry for the fixed-income allocation is that “expected” capital market returns for the allocation have to be in the 2% – 2.5% range (if that) for the foreseeable future given the absolute low level of yields we see today. Client’s fixed income allocation is simply to “hold serve” and not give up too much in return, with client’s equity allocation and stock selection used for generating upside to the benchmark.
Summary / Conclusion: Clients are benchmarked to the traditional 60% / 40% asset allocation, but tactical bets are made with the major asset allocation weights to benefit from secular bull markets, so the equity weight is higher within client accounts the last few years (and thus the fixed income weight lower than 40%) and further tactical bets are made within sectors and fixed income asset classes to collect “alpha” where it can be made.
Because clients are all retail accounts the overlying mantra is to keep it simple and understandable for them.
The SP 500 valuation (in my opinion) remains quite reasonable at 18x forward earnings today with 10% forward growth expected, and using sentiment measures (bullish sentiment today is still considered just average despite the 2019 returns)m and market breadth is still positive, we continue to think the SP 500 remains in a secular bull market that is in it’s 5th or 6th inning. If readers would look at history, post WW II, you have secular bull markets that last usually 15 – 20 years and this bull market is anywhere from 7 to 10 years old, depending on your starting point of March 9, 2009 or April – May, 2013, when the SP 500 made its first new all-time-high above the March, 2000 and October, 2007 highs.
In terms of the SP 500 valuation, we’ve seen three 20% corrections since the March ’09 generational lows for the SP 500, and that was 2011 (May to early October, and roughly 20% in severity), mid 2015 to early 2016 (China devaluation driven and the collapse in crude oil prices, and roughly 14% in severity), and finally the 4th quarter of 2018 correction that corrected 20% peak-to-trough and then rallied 6% in the last week of the year.
The point is these corrections are not “technically” bear markets they continue to be corrections in an ongoing secular bull market. Bear markets erode client capital over long periods of time, like from March 2000, through March, 2009. (And that is strictly a personal opinion.)
If the above is wrong, the expectation is that the SP 500 return will be higher in 2020 and the Aggregate lower, as SP 500 earnings growth, GDP growth, and non-US economic growth is better than expected.
Hope this helps – please feel free to disagree.
This is not advice either, but just one perspective on what 2020 might look like. Take these prognostications with a healthy degree of skepticism, since they are probably wrong to some extent or degree.
The one thing Wall Street fails to tell mainstream America is that no one – absolutely no one – can predict the future with regularity, and that no one firm, style, methodology, strategy, can successfully work all the time.
2008 – which I don’t think will be repeated in my lifetime – or ever maybe – destroyed many illusions about diversification and managing risk.
Thanks for reading.