Past
Commentaries
12/20/2019
Current Commentary
To My Clients, Friends, & Observers:
As good as this year has been, it doesn't get me excited. It had to happen eventually and the market has been struggling to make a run at 3000 for almost 2 years. The high close for the S&P 500 was 2872 on January 26, 2018; 2929 on Sep 21, 2018; 2924 on May 1, 2019; 3025 on July 26, 2019; 3006 on Sep 19, 2019; and now 3191 at yesterday's close. That's a return of just over 11% on those highs for the past 23 months - a good illustration of investing "at the top." What makes this year look so good is the technically-driven 16% collapse last December that predicated the sharp V-shaped recovery that started the day after Christmas.
Consider the coastline from New York to Boston. It is physically impossible to accurately measure a coastline. And why bother? A coastline is a pattern of ever-changing fractals. Market price patterns are also fractals. It is more practical to consider the distance from New York to Boston as the crow flies, or by I-95. And it is more constructive in investing to observe regression lines, moving averages and trendlines than short-term price gyrations (volatility).
The factors weighing on the market in 2019 were the China trade war, eroding corporate earnings projections, an inverted yield curve and threats of recession. The index of leading economic indicators hovered around 50 all year, dropping below twice. Under 50 is recessionary, over 50 is expansive. Through the end of November the LEI are 58. (Coincident and lagging indicators remained well above 50 all year).
Now at year-end, the China trade seems to be reaching an accommodation, the yield curve has normalized, the Fed has lowered rates and may cut once or twice more. Corporate earnings will have grown a meager .8% this year, down from growth of 22.7% in 2018. Corporate EPS are estimated to grow next year between 5.5% (Yardeni Research) and 8% (CFRA Research). The odds of recession in the next 12 months are less than 30%. The labor force participation rate is improving and unemployment remains at a 50-year low.
There are some more tailwinds in 2020. In 4th year presidential election years the market is up 70% of the time (69% for Republican, 71% for Democrat administrations). The $10,000 limit on state and local tax deductions may be revised upward - effectively another tax cut. Energy, particularly oil, is cheap and should remain so.
The not so good news is that the market has probably discounted all this. It's priced in right now. The S&P is trading at 24 times the last 4 quarters earnings. Its dividend yield is 1.79%. If I had to speculate - and I don't - I would estimate the S&P to reach a level between 3400 and 3600 next year, with no P/E expansion.
One chronic problem that remains without resolution - or attention - is debt. Corporate debt is not a concern; the public debt is. Perversely, this actually works in our favor. Any significant increase in interest rates would drive the cost of debt service to calamitous levels. It would crowd out any other constructive expenditures.
There are only two sources of funding available to sustain severely unfunded, public pension obligations. They are 1) property taxes and 2) better investment returns. There are politically risky limits to the publics' toleration of property tax increases. Actuarial assumptions for unrealistically high investment returns are the norm for large public pensions. We can infer that there is fundamental institutional support for positive returns from the equity markets.
Where are investments placed in a chronically low interest rate environment? We have a real case by way of example. Japan's central bank went to zero rates in 1999. At that time the Nikkei 225 Exchange traded at 14,335. Today the exchange trades at 24,000 with a P/E ratio of 18.95 and a dividend yield of 2.1%. Yen that could not be invested at 0% was invested in equities instead.
Much depends on the bond market. A rapid rise in interest rates or inflation could precipitate a bond market crash that would be compounded and accelerated by liquidations of bond ETF's. And that, notwithstanding arguments to the contrary, could trigger a stock market blow-off.
Longer term I expect a lower and slower rate of growth. Even China's GDP is forecast to be between 4% and 5.5% next year. For individual investors, the rate of dividend increases is critically important. I estimate dividend increases on S&P 500 stocks in the range of 5% to 7% in 2020. I also expect some periods of significant volatility. The market has gone a year without a 10% correction and any number of factors could provoke one.
Retirement planning should address five components: Income, Investments, Taxes, Health Care, and Estate Planning. There is a new Federal law that will take effect the first of the year, The SECURE Act. The acronym stands for Setting Every Community Up for Retirement Enhancement. (How many millions were spent coming up with that title?) It may have an impact on your retirement planning and it is important to review its potential impact. Some of the highlights: an end to the stretch IRA for beneficiaries, total distribution must be made within ten years of the death of the benefactor; a delay of the Required Minimum Distribution from 70 1/2 to 72; and no limit to the age at which a worker must cease retirement plan contributions. With taxes likely to increase in the future, a careful analysis of Roth IRA's is warranted.
Best regards,
Dennis M. O’Connor
