Global Asset Allocation Views – Q1 2020
The S&P 500 closed 2019 at a record high and trending in the opposite direction from 2018’s December low. Below I provide the returns of the S&P 500 over the past three years and the largest intra-year declines for context.
2017 – Closed up 19% / intra-year decline -3%
2018 – Closed down -6% / intra-year decline -20%
2019 – Closed up 29% / intra-year decline -7%
2018 and 2019 were also opposites in other areas
| 2018 | 2019 | |
| Global Manufacturing | steady | contracting |
| Trade Tensions | minimal | escalated |
| Monetary Policy | tight | easy |
| Profit Margins | strong | weakening |
| Valuations | low | extended |
The outlook for 2020 is for positive, yet below average, returns as the markets look to digest rising tensions with Iran, the pace of inflation, shrinking profit margins, and the 2020 US presidential election.
The S&P level I am monitoring is the December low 3093.2. A fall through this level may lead to a prolonged drawdown similar to what we saw in 2018.
2020 Outlook
The 2010s saw a large outperformance by US large cap, mostly growth-oriented tech companies, relative to all other asset classes. The question to ask is, how long can this continue and at what point will mean reversion take place?
The 2000s saw the opposite effect with international markets, small cap, and commodities all outperforming large cap. Large cap even finished the decade in negative territory. We continue to favor large cap as we enter this decade but maintain a global approach to investing. We do not want to focus on only what has done well in the near-term, but what has the potential to surprise in the future.
Risks for 2020
Monetary Policy – The Fed is pricing in zero rate cuts over the next two years with one hike in 2022. Markets are still predicting a rate cut both this year and next. Fed Chairman Powell seems to have found his footing and has made it clear that inflation will be the variable that he monitors when it comes to raising rates. Some Fed presidents have expressed, both publicly and privately, that they fear keeping rates too low will lead to excessive risk-taking that could lead to another bubble.
Inflation – inflation has been steadily creeping up with wages continuing to rise lowering companies’ profit margins. As mentioned previously this is the main variable being watched by the Fed. To position portfolios for higher inflation I will look to commodities, such as gold, and TIPS
Valuations – company valuations finished 2019 at elevated levels as we saw stock prices continue to trend higher even though earnings stumbled. For the market to take another leg higher we will need to see higher earnings to warrant owning stocks at more elevated valuations.
De-escalating Trade Tensions – President Trump announced he will sign phase one of a trade deal with China on January 15. There are not many details yet into what is all involved but this reprieve will continue to support market sentiment and hopefully lead to a capex recovery, which had been inhibited by trade uncertainty.
Global Economy – though markets were strong in 2019, the global economy is still coming out of a contractionary environment led by primarily trade uncertainty and its effects on global manufacturing. Along with earnings, for the markets to take another step higher we will need economic conditions to improve to justify higher valuations.
Tensions with Iran – On January 3, President Trump gave the ok to take out Iran’s top general of the Quds force, Qasem Soleimani. A full-blown war is unlikely, but proxy wars fought by Iran backed militias against US backed allies should not be discounted. Oil shocks like the ones seen in the 1970s or after the 9/11 attacks have become less and less likely. Last year when two Saudi refineries were taken offline temporarily, oil markets spiked before giving up all gains within a week. The increase in US production has provided less volatility in the oil markets.
2020 US elections – the fourth year of a president’s term tends to be the second strongest year outside the 3rd year. A Trump victory or a win by a moderate Democrat with a divided Congress would be seen as a positive outcome. The worst outcome would be a win by either Senator Sanders or Warren with full Democratic control of Congress.
Model Changes
Energy to Neutral and Financials to Overweight
- The energy sector has not been able to catch up to the price of oil in terms of performance. The energy sector’s weighting is currently at 4.7%. Ten years ago the weighting was closer to 11%.
- Financials are trading at a discount from the S&P 500 and have just taken out the pre-Financial Crisis highs from 2007. With a dovish Fed, I see more upside in this sector relative to energy.
These are the opinions of Antonio Belmonte and not necessarily those of Cambridge, are for information purposes only, and should not be construed or acted upon as individualized investment advice. Investing involves risk. Depending on the types of investments, there may be varying degrees of risk. Investors should be prepared to bear loss, including total loss of principal. The strategies discussed herein are not designed based on the individual needs of any one specific client or investor. In other words, it is not a customized strategy designed on the specific financial circumstances of the client. However, prior to opening an account, Cambridge will consult with you to determine if your financial objectives are appropriate for investing in the model. You are also provided the opportunity to place reasonable restrictions on the securities held in your account.
Written by: Antonio Belmonte, CFA, Chief Investment Officer