Outlook: H1 2020
CIO Chris Perras welcomes listeners to the new year, and dives right into Oak Harvest’s markets outlook of the first half of 2020!
Chris Perras: Hey there. My name is Chris Perras. I’m the chief investment officer here at Oak Harvest Financial Group in Houston, Texas, and welcome to the January 3rd edition of our Stock Talk podcast. This podcast can be a little longer than normal and definitely longer than last week’s because it’s going to be a summary of our first-half market outlook. We published this earlier in the week, but want to read through it for our podcast listeners.
On January 4th of 2019 earlier this year, the S&P 500 was trading at 2,475. At that time, most advisors were urging caution and a great deal of the financial press was warning of impending crashes and coming recessions. On that day, the team at Oak Harvest Financial Group first published our first half, 2019 outlook, and it was entitled “Put on your rally caps.” It read as follows. “Given the sharp rise in stock market volatility to reading over 35 on the VIX index and a subsequent market fall in stocks in the fourth quarter of 2018, we are highly optimistic about stock returns in 2019.
We believe that the market can fully recover and hit new all-time highs by year-end 2019. Let’s call it S&P 500 3,000 optimistically, and at that time, the S&P 500 was pinned at 2,475. In retrospect, we were too conservative and too low in our positive outlook. However, we would rather err on the side of caution than rather err on one of exuberance. Fast forward to June 14th, 2019 with the S&P 500 trading at 2,885. If you first recall, 2,885 on the S&P 500 was flat with the same level as February 2018.
On June 4th of this year, we published our second-half outlook for 2019, and it was 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 a new all-time high of close to 3,000 to 3,050 on the S&P 500. Okay, we were off of touch back then. The S&P 500 reached 3,028 in late July.
Moreover, at that time, we saw a normal summer pullback inequities of 5% to 6%. As a matter of fact, it ended up going down 5.98% during the summer. Additionally, we forecasted a very normal fourth-quarter rally caused by lower volatility brought on by the Federal Reserve easing cycle, which would lead to new all-time highs in the S&P 500 of at least 3,100. 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. Each year will not happen with such precision and accuracy as 2019 did, because few years will 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 static 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 on this year, 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 and ’16 period for 2018, 2019. We see this trend continuing at least through the first half of 2020, with the upcoming first quarter and second quarter of 2020 being similar in nature to the first half of 2017. From where we sit near 3,200 on the S&P 500, the team at Oak Harvest sees an additional 5% upside in the first half of 2020.
Let’s call that 3,300 to 3,400. Okay, we’ll call it 3,350 on the S&P 500. Throughout the coming months, pullbacks in the market should be constrained in the overall price, percentage decline, and length of time. Normal market pullbacks in this kind of environment are typically confined to 1.5% to 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 we’ve tried to teach you here at Oak Harvest? That is, don’t fight the Federal Reserve. Repeat after us, don’t fight the fed.
The Federal Reserve reversed course in January of 2019 and has been providing increased liquidity to the markets since the second half of 2019. 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 repos, 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. The team at Oak Harvest continues to say the same old song, whistling the same tune. What’s the name of that tune? The name of that tune is easing. Let’s 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 dead zone in the blackout window and re-enter the corporate stock buyback window.
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? Well, there is some concern that a Liberal-leaning 2020 presidential candidate will 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. An index funds and ETFs are price-agnostic buyers and sellers of equities. Third, another large buyer of equities resurfaces earlier in the year and should compete for the trading float of equities throughout the first quarter of 2020, pushing up prices.
Who was this buyer? Well, listeners, this buyer is you and your 401(k) contributions. At the beginning of each calendar year, your 401(k) contributions reset to zero. If you invest through an automatic 401(k) 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 up at least 5% higher in the first quarter is lower volatility.
It seems that the team at Oak Harvest was one of the few investment managers to see this trend early in 2019 and call it out for 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 time period the second half of 2016 and ’17, 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 relatively low market volatility environment in 2020. Please remember, this type of trend develops over months and quarters, and we are not talking about intraday volatility caused by tweeting or headline news stories. Finally, we see an 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, or both.
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 lifeblood of the overall market and of single stock return over time. Remember, there are three major indicators that you can watch in real-time that alerts you that Goldilocks and the stock market have 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 in past podcasts and outlooks. What are those real-time indicators? 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 revenues now come from overseas markets. The second Goldilocks indicator is a gently rising yield curve and slowly rising long-term interests rates. Why? Because it indicates faster economic growth, or higher inflation, or both are coming into the economy. These two factors are paramount for driving higher corporate profits.
For example, the financial service sector, as represented by banking and brokerage services, accounts for over 15% of the S&P 500 index weighting and even more of a percent weighting in earnings. Higher-trending long-term interest rates are a boon to the earnings of most financial companies. The third of the Goldilocks indicator is oil pricing. Slightly higher oil price tends to drive energy sector earnings and indicates an upturn in overall global growth. The other two secondary indicators of Goldilocks are the direction of copper pricing, that’s for global growth and the direction of lumber pricing, and that’s for US housing demand.
From a price perspective, we see the S&P 500 returns being front-end loaded in the first half of 2020 and reaching, call it, 3,350 midway through the first quarter of the year. 3,350 on the S&P 500 is roughly a 5% return from current levels. Another 2% upside is possible to roughly 3,400 through the first half of 2020. However, if we should reach that level too early in the year, the team at Oak Harvest would view this move as too far, too fast, and we would look to rebalance investor allocations.
Early 2020 should see a continuation of its “It’s time to play offense” theme the investment team at Oak Harvest first laid out back in mid-August of 2019. By playing offense, we mean that being overweight in asset classes, such as small-cap stocks, international, emerging market stocks, and overweight sectors like technology, consumer discretionary, industrial, and financial stocks are most likely 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 gain is likely to slow come the mid-first quarter of 2020 due to a confluence of three factors. First and foremost, the Federal Reserve recently initiated the October 15th, 2019 short-term bond-buying program. You use to stabilize that overnight repo market is scheduled to peak and slow come mid-February.
From this point on, and on the schedule, it’s actually February 15th of 2020, liquidity momentum, while high, will peak and likely slow. This is likely to lead to an upturn in market volatility and a slower rise in the overall market. This is a slowing and the easing is an easing equation that has supported stocks since the pivot up in early October 2019. Secondly, starting later in the first quarter of 2020, investors who are prescient enough to buy equities in the sell-off 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 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 likely cause some additional sellers to emerge.
Finally, and our long-term listeners have heard this mantra before from us, come late February, corporate stock buyback momentum for the first quarter will peak. We’ll enter the dead zone and quiet period for the first quarter earnings report 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 inequities in the first half of 2020.
Several listeners of this podcast have asked for reviews on more speculative fund asset classes. While not an asset class that the team at Oak Harvest allocates funds to, I viewed Bitcoin as an investable for more aggressive investors’ asset for the first time in early 2019. From January 4th, 2019, Bitcoin rose from roughly $3,905 to peak intraday on June 26th, 2019 at about $13,765. It subsequently has fallen back to around $7,500, 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 in 2020, the upside on Bitcoin could be multiples of what it was in 2019. By multiples, I mean that the final speculative blow-up move in the asset class would resemble something as it did in late 2017 and early 2018. In that scenario, Bitcoin could trade close to, yes, $200,000.
I want to remind listeners and readers that the investment team at Oak Harvest is constantly evaluating our economic outlook. Regardless of what we feel might or should happen, we manage your monies for your financial goals and needs. At Oak Harvest, we look for value where others are fearful. Moreover, we accelerate investments when other investors’ emotions and panic cause short-term volatility. I’m Chris Perras, chief investment officer at Oak Harvest Financial Group here in Houston. Remember, our main goal is to help you retire only once in your life with a customized retirement planning. Many blessings and this concludes our first half 2020 outlook.
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CFA®, CLU®, ChFC®
Chief Investment Officer, Financial Advisor
Chris is a seasoned investment professional with over 25 years of experience working with some of the most successful money management firms in the world. Chris has made it a point in his career to adapt as the market landscape changes, seeking to utilize the appropriate investment strategy for a given market environment. His transition from managing billions of dollars at the institutional level to helping individuals and families retire is guided by a desire to see first-hand the impact he is making in the lives of clients at Oak Harvest.