Summary
- Can equity markets repeat the stellar performance of 2019?
- Complacency about clearer skies likely taking the ‘margin of error’ away.
- Healthcare, Utilities in non-cyclical and Tech and Energy in cyclical sectors could deliver relative outperformance in 2020, supporting the market sentiment going forward.
- Risk of high global indebtedness is so far covert, yet quite alarming.
- “Bull markets don’t die of old age “… but still, the current recovery since 2009 is one of the longest in history (post-war)
2019 was a stellar year for global markets and most asset classes.
Asset Class Returns 2019
Source: Novilinvestor.com (US assets, Total Return, USD)
It is a proof of investors’ resilience despite puzzling central banks actions, a reversal of multinationalism and global trade, and fears of an economic slowdown. We saw yield curve inversions in bonds and very sharp style rotations in equities. Value as style had a strong coming back at end-3Q2019, though its leadership over growth peaked around mid-December.
Not every year can the S&P 500 deliver 31.5% in total return! But when you break this phenomenal return down into its attributes (below), the major portion is multiples expansion with dividends and EPS growth contributing hardly 5% combined. This suggests the expectations for 2020 are quite high for a year already facing one of the toughest ‘comparisons’ in history.
S&P Total Return Attribution, 2019
(EPS growth, multiple expansion, dividend)
Source: Wells Fargo
So far skies appear clear at the dawn of 2020. The FED continues to expand its balance sheet and inject unprecedented liquidity into the markets. ‘Phase one’ deal between China and the US is a progress in the right direction. The global economic data is bottoming and surprising on the upside. Several large emerging markets are embarking on new economic cycles and readying themselves to capitalize the opportunity offered by an expectedly weaker USD.
Citi Economic Surprise Index, Global
Source: Bloomberg
Going forward, the focus will likely shift on the sustainability of this goldilocks scenario against the late cyclical economic environment in developed world. Steepening of the treasury yield curves could likely continue as the FED continues to buy short term treasuries in its balance sheet expansion. The Sino-US trade dispute is multi-faceted. China continues to diversify its exports in a drive to reduce dependence on the US. Consequently it is now world’s major trading partner, replacing the US.
China Overtook the U.S. as the World’s Major Trading Partner
Source: Lowy Institute, IMF
As ‘phase two’ Sino-US trade negotiations begin, so does a ‘tech cold war’ between the two major economies. Speaking of which, Huawei remains in the spotlight with its 5G projects facing political blockages in the west on orders from the White house.
Key beneficiaries of Sino-US trade frictions and rising cost of operating in China have been the Emerging Markets (EM) in Asia Pacific like Vietnam and Indonesia. EM bourses as a group have a negative correlation with the USD. As the USD supply increases through FED’s liquidity injections, a weaker dollar could help Emerging Markets recoup some of the 110% underperformance vs. developed markets of the past decade.
In terms of sectors, healthcare looks attractive from the non-cyclicals group. A relative underperformance of 2019 leaves the sector’s valuation reasonable. Besides it is among the few sectors likely to deliver margins expansion and positive EPS growth in 2020. Political noise in an election year is a wild card, but what’s missing is a true political motivation needed to push for and do the heavy lifting required in legislating healthcare reforms like Medicare-for-All. Utilities on the other hand are seeing political tailwinds supporting renewables-fueled generation businesses. The ESG and environmental factor is playing its role. Besides the sector remains profitable and cash generative.
From cyclicals, technology and what is termed as FANG+ delivered outstanding performances in 2019. This could continue as 2020 sees an increasing participation from the semiconductor segment following clarity on global growth fears and trade wars that temporarily withheld new orders. Energy remains a double-edged sword. Oil price could find support in crude demand from emerging markets and peaking US-shale production. A global ESG-drive and the ‘end fossil fuel’ lobby are diverting passive moneys away from the sector – though this negative is sufficiently discounted.
S&P 500 Sector Performance
Source: Novelinvestor.com
S&P 500 Sector Valuations, current levels vs. 5-year average
Source: Bloomberg, oshares.com
What are the main risks? The killing of Iranian general and brief standoff between the US and Iran had almost no impact on the markets. The S&P hardly budged 1%, with persistently low VIX (volatility). Similar geo-political tensions in the recent past like Russia’s invasion of Crimea or troubles in the Middle East have proven to play no role in supporting or derailing the global economic growth.
On the other hand, a bigger risk is in the form of global indebtedness. The latest Institute of International Finance (IIF) report suggests the global debt will likely reach USD 257 Trillion in 1Q2020, implying a global debt to GDP ratio of 322%. Highest ever! For China the situation is worrisome as its debt to GDP reaches 310%. Other parts of the world including Europe (France, Belgium, and Switzerland etc.), Asia Pacific and Africa have also levered up to historic high levels.
Global Debt $ trillion and as % of GDP
Source: Institute of International Finance
What is more alarming about the global indebtedness is the leverage accumulated by the non-financial sector and the governments. A contrast to the arrival of the GFC when the financial sector was the most levered in 2007. While states and governments came to its rescue, will it work the other way around if needed?
Global Sector Indebtedness ($Billion, Q1 of each year)
Source: Institute of International Finance