First Half 2020 Market Outlook
By Chris Perras, CIO.
To listen to the Outlook, click here!
"Stay Long and Carry On"
On January 4th, 2019 the S&P500 stood at 2475. Most advisors were urging caution and a great deal of the financial press was warning of impending crashes and coming recessions. On that day, our team at Oak Harvest Financial Group first published our first half 2019 outlook entitled “Put On The Rally Caps”. It read as follows, “Given the sharp rise in stock market volatility to a reading over 35 on the VIX index and subsequent dramatic fall in stocks in the 4th quarter of 2018, we are highly optimistic about stock returns in 2019. We believe the market can fully recover and hit new all-time highs by year end 2019! Call it S&P500 3000 optimistically." At that time the S&P500 was pinned at 2475. In retrospect, we were too conservative and too low in our positive outlook. However, we would rather err on the side of caution rather than on one of exuberance.
Fast forward to June 14th, 2019, with the S&P500 trading at 2885. If you will recall, 2885 on the S&P500 was flat with the same level as February 2018. On June 14th, we published our second half outlook for 2019 entitled “Goldilocks Returns”. In it, while others were warning of recessions, Chinese trade wars, and Brexit disasters, we called for a normal stock market rally into August reaching new all-time highs of close to 3000-3050 on the SP500. (Ok, we were off by a touch. The S&P 500 reached 3028 in late July).
Moreover, we saw a normal summer pullback in equities of 5% to 6% (it went down 5.98%). Additionally, we forecast a very normal 4th quarter rally caused by lower volatility brought on by a Federal Reserve easing cycle leading to a new all-time high on the S&P 500 of at least 3100. In retrospect, we were once again a bit too low. Even our podcast on October 4th, pointing to the beginning of a pivot higher in equities after 20 to 21 months of sideways turned out to be pretty spot on.
Every year will not happen with such precision and accuracy as 2019 did, because few years will likely play out as normally as 2019 did. However, the team at Oak Harvest will do our best and share with our listeners and readers our thoughts on the first half of 2020.
As frequent listeners and readers might recall, we actually took our first stab at 2020 way back in June of this past year 2019. Yes, our second half 2019 outlook written back in June actually includes our first thoughts about 2020. As of this writing, we do not feel compelled to change that outlook. If the second half of 2019 was the return of “Goldilocks” for stocks, the first half of 2020 should be titled “Stay Long and Carry On “.
As we stated throughout all of 2019, we see an almost perfect analogy in the markets of the 2015-2016 period for 2018-2019. We see this trend continuing at least through the first half of 2020 with the upcoming Q1 and Q2 being similar in nature to the first half of 2017. From where we sit near 3200 on the SP500, the team at OHFG sees an additional 5% upside in the first half of 2020, call it 3300-3400, call it 3350 on the S&P 500. Throughout the coming months, pullbacks in the market should be constrained in overall price, percentage decline, and length of time. Normal market pullbacks in this kind of environment are typically confined to 1.5-2% down moves that last about a week in time.
Why do we see this? First and foremost, if you are going to use macroeconomics to try to help you invest, what’s the number one sacred rule? “DON’T FIGHT the FEDERAL RESERVE!” Repeat after us…DON’T FIGHT the FED! The Federal Reserve reversed course January of 2019 and has been providing increased liquidity to the markets since the second half of 2019 began.
Starting this past October, in response to a spike in overnight cash interest rates, the Federal Reserve decided to expand its balance sheet again. Through overnight repurchase agreements, known as “Repo’s”, the Federal Reserve is easing year end liquidity crunches in overnight lending markets. Some are calling this “QE4”. Others, mainly hedge funds and short sellers, are calling it far worse things! The team at Oak Harvest continues to sing the same song, whistling the same tune. The name of that tune is? ”Easing is Easing”. Call it whatever you want. It’s positive for markets.
Besides an easier credit environment, a second reason for believing in a strong January through February in the stock market is that we exit the “deadzone and blackout window” and reenter the corporate stock buyback period. Starting the second week in January, potential buyers of stocks will begin fighting with corporations as the corporate buyback window opens. We expect that even though stocks are up considerably year over year, many companies will accelerate their stock buybacks in early 2020. Why do we see this? There is some concern that a liberal leaning 2020 Presidential candidate would look to implement anti-shareholder friendly regulations should they be elected. This belief can lend further support to a continuation of the rally in the first quarter of 2020 as index funds and ETFs are now holding an increasingly high percentage of the outstanding float of most companies. Index funds and ETFs are price agnostic buyers and sellers of equities.
Thirdly, another large buyer of equities resurfaces early in the year and should compete for the trading float of equities throughout the first quarter of 2020 pushing up prices. Who is this buyer? This buyer is you!!!.... and your 401k contributions. At the beginning of each calendar year, your 401k contribution resets to zero. If you invest through an automatic 401k investment plan, you and your choices start buying more stocks each and every payday in the new year. Presto! More demand for stocks in the new year.
Another factor that should contribute to pushing stocks at least 5% higher in the first quarter is lower volatility. It seems that the team at OHFG was one of the few investment managers to see this trend early in 2019 and call it out as the tailwind that it is. Whether by desire or chance, the Federal Reserve controlling credit has also affected overall market volatility the last few years.
When credit conditions are easy (think of the second half of 2016 and 2017), volatility typically declines and very few legitimate buying opportunities surface. The chances to “buy the dip” are infrequent and even those dips that do occur are shallow and brief. Contrary to most market pundits, we continue to expect a low market volatility environment in 2020. Please remember, this type of trend develops over months and quarters! We are not talking about intraday volatility caused by tweeting or headline news stories.
Finally, we see overall S&P 500 earnings and earnings estimates for 2020 being too low. Remember, Goldilocks for stocks is a market of either rising growth expectations or gently rising inflation. Why is that Goldilocks? Because those macroeconomic factors lead to accelerating earnings growth in the stock market a few quarters out. Remember, earnings and earnings growth rates are the life blood of the overall market and single stock returns over time.
Remember there are three major indicators that you can watch in real-time that alert you that “Goldilocks” in the stock market has returned. Recall, they are not things like GDP growth, consumer confidence surveys, or durable goods orders that are often quoted on the financial news channels. We’ve discussed these indicators on previous podcasts and outlooks.
The real-time indicators are first, a dollar that is trending gently lower. Why? A lower trending dollar supports earnings growth in the overall market as over half of the S&P 500 revenue comes from overseas markets.
Secondly, a gently rising yield curve and slowly rising long term interest rates indicate a Goldilocks for stocks environment. Why? Because it indicates that faster economic growth or higher inflation, or both are coming to the economy. These two factors are paramount for driving higher corporate profits. For example, the financial services sector as represented by banking and brokerage services account for over 15% of the S&P 500 index weighting and even more in earnings. Higher trending long term interest rates are a boon to the earnings of most financial companies.
Third of the Goldilocks indicators is oil pricing. Slightly higher oil price trends drive energy sector earnings and indicates an uptick in overall global growth. The other two secondary indicators of Goldilocks are the direction of copper pricing (for global growth) and the direction of lumber pricing (for US housing demand).
From a price perspective, we see the S&P500 returns being front end loaded in the first half of 2020 and reaching 3350 midway through the first quarter of the year. 3350 on the S&P500 is roughly a 5% return from current levels. Another 2% upside is possible to roughly 3400 through the first half of the 2020. However, if we should reach that level early in the year, the team at Oak Harvest would view this move as “too far too fast” (TFTF for short) and we would look to rebalance investor allocations.
Early 2020 should see a continuation in the “it’s time to play offense” theme the investment team at OHFG first laid out back in mid-August of 2019. By playing offense, we mean that being overweight in asset classes such as small capitalization stocks, international, and emerging market stocks, and overweight sectors like technology, consumer discretionary, industrial, and financial stocks are the places to be more heavily invested. Safer, low and no growth, and less volatile sectors such as utilities and staples should continue to lag on a relative basis.
The pace of the market gains is likely to slow come mid-first quarter of 2020, due to the confluence of three factors. First and foremost, the Federal Reserve’s recently initiated (October 15th, 2019) short term bond buying program used to stabilize the overnight “repo market” is scheduled to peak and slow come mid-February. From this point on (scheduled February 15th, 2020), liquidity momentum, while high, will peak and slow. This is likely to lead to an uptick in market volatility and a slower rise in the market. This is a slowing in the “easing is easing” equation that has supported stocks since the pivot up early in October 2019.
Secondly, starting later in the first quarter of 2020, investors who were prescient enough to buy equities in the selloff of late 2018 and early 2019 will have gains that flip from short term to long term in nature. With the overall stock market up considerably since the 2018 Christmas eve lows, many investors might look to book long term capital gains. Why? Because investors marginal tax rates drop dramatically versus a realized short-term gain after a one year holding period. Moreover, the uncertainty of future tax policy changes due to the upcoming 2020 Presidential election will probably cause some additional sellers to emerge.
Finally, and our long-time listeners have heard this mantra before, come late February, corporate stock buyback momentum for the first quarter will peak. We will enter the “deadzone” and quiet period for first quarter earnings reports through March into early April. This removes an incremental buyer of stocks from the demand equation for four to six weeks at the end of the first quarter and typically stock gains slow.
We do not believe that any of these factors should lead to a substantial downturn in equities in the first half of 2020.
Some folks have asked for our views on more speculative asset classes. While not an asset class that the team at OHFG allocates funds to, we viewed Bitcoin as potentially investable for more aggressive investors for the first time in 2019. From January 4th, 2019 Bitcoin rose from roughly $3905 to peak intraday on June 26th at about $13765. It subsequently has fallen back to about $7500 yielding a return to date of a volatile, yet very positive, 92%.
For 2020, Bitcoin could remain a highly positive returning speculative asset. Should the positive trading pattern that we saw develop in Bitcoin continue into 2020, the upside on Bitcoin could be multiples of what it was in 2019. By multiples, we mean that the final speculative blowoff move in the asset class would resemble its late 2017 and early 2018 move. In that scenario, Bitcoin could trade close to $200,000. A reminder that our view is not a recommendation, and since this asset class is so volatile and speculative, we do encourage caution for anyone considering it. Talk to your financial advisor for specific advice for your personal situation.
I want to also remind listeners and readers that the investment team at Oak Harvest is constantly evaluating our economic outlook and adjusting our portfolio as we see opportunity and valuation anomalies. Regardless of what we feel “might” or “should” happen, we manage money for your financial goals and needs, and we adjust portfolios for what is actually happening in the economy and the markets. At Oak Harvest, we look for value when others are fearful. Moreover, we accelerate investments when other investors’ emotions and panic cause short term volatility.
I’m Chris Perras, CIO at Oak Harvest Financial Group here in Houston, Texas and remember, our main goal is to help you retire only once in your life. Many blessings.
This concludes our first half 2020 outlook.
Sources for data include Bloomberg, Investor’s Business Daily, other publicly available news sources, and Oak Harvest internal analysis. This forecast contains the generalized view of Oak Harvest Investment Services and should not be considered personalized investment advice. No assurance is made that Oak Harvest Investment Services will continue to hold the views expressed herein. Views and opinions may change based on new information, analysis, or reconsideration. Oak Harvest makes no assurance as to the accuracy of any forecast or projection made. . Investment strategies mentioned may not be right for you. Any investment strategy depends on your personal situation, risk tolerance, and objectives and should be undertaken after consulting with your financial advisor. Past performance is not indicative of future results. Investing involves the risk of loss.
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