Market Strategy 1/13/2020

• This week we provide further detail on our global asset allocation and sector weightings for 2020.
• With the pending signing of the Phase One trade agreement scheduled for this week investors will be watching for the markets’ reactions. The signing of the agreement should usher in a ramp up in expectations for global growth and equity and earnings growth.
• Last week’s nonfarm payroll report suggests that the US economy continued to grow in late 2019 albeit at a more modest pace than some expected.
• Last week’s services ISM report showed continued strength with a 2% rise in December.

Having initiated a year-end 2020 price target of $3500 for the S&P 500 on December 17, 2019, based on our earnings estimate of $175 per share and a slight expansion in the multiple to 20x earnings, we turn our attention this week to consider what tweaks may be called for in our global asset allocation model and our sector weightings for the S&P 500.

We take into consideration the recent progress made toward resolving the trade war between the US and China, as a Phase One agreement now awaits the signatures of the two nations’ leaders (the partial agreement calls for the US to cut its tariff rate by half on $120 billion of Chinese goods that have been subject to a 15% tariff since September 1, 2019). The de-escalation of the trade war begins the removal of a major source of uncertainty that was undermining business confidence, roiling global supply lines and causing many firms to pause or reduce investment spending.

We also discuss other factors that include cyclical and secular trends and thematic investment ideas that present opportunities as well as some risks for 2020 in the context of the recent advances in stocks.

The main outlines of our view remain intact

• We remain overweight equities globally, with a tilt toward US stocks in particular while maintaining meaningful exposure to international developed, emerging and frontier market stocks;
• Cyclical sector stocks are more attractive than defensives in our view as we believe that the almost 11-year old US economic expansion still has room to run;
• We remain market cap agnostic, preferring to keep roughly similar exposure to US large, mid- and small cap stocks.
• Rewards await those who are patient and watch for “babies that get thrown out with the bathwater” during periods of volatility.

In our view the year that just ended should serve to provide a platform for further equity market gains as well as the outperformance of equities over other asset classes on a confluence of tailwinds that include: 

• US monetary policy that remains sensitive to both growth factors as well as vulnerabilities on the economic landscape.
• The current policy stance by the Fed in our view favors low interest rates, jobs growth, business fixed investment spending, moderate wage growth and flow into equites and real assets.
• Modest reflation in the US and eventually international economies driven by counterinflationary trends embedded in globalization and technology.
• A cheaper US dollar as the “safe haven” flows that boosted the greenback (and Treasury prices) in 2019 recede and investors seek riskier assets and higher returns;
• Better comparisons in earnings seasons ahead (compared to 2019) as global growth begins to re-accelerate;
• The possibility of election year stimulus spending in the US, perhaps to include higher infrastructure outlays;
• Potential for further progress in resolving the trade war’s remaining sticky issues;
• A reacceleration of cyclical and secular growth trends that were negatively impacted by the trade fracas. 

While the tailwinds for stocks in 2020 appear reasonable and likely to bring stronger results for corporate revenues and earnings, many risks still remain, including:

• Valuation risks (should stocks become overbought);
• Capitulation by bears and skeptics that leave everyone “on the same side of the boat”;
• The potential for a misstep by the Federal Reserve or a misunderstanding of monetary policy by the market (remember the “Taper Tantrum”?);
• A breakdown in trade talks should the negotiation of complex economic and trade issues lead to either side walking away from the negotiation table; 
• Expansion of the trade fracas with China to other nations in Europe, Asia or Latin America; 
• US domestic (election year) politics leading to further gridlock in the world’s largest economy; 

That said, our expectations at this time are that challenges known to exist that could impede the equity markets’ progress are likely to be offset by enough positive factors (whether from resilient economic data or improvements in corporate revenue and earnings growth) to be surmountable as has so often happened since the recovery from the financial crisis began more than ten years ago. In such a scenario stocks could continue to grind higher, climbing the proverbial “wall of worry.” 

We suggest that even as fundamentals improve investors should refrain from expecting that economic growth or stock prices will move up in a straight line but rather that they should right size their expectations and be prepared for a “two steps forward, one step back” journey in a “progress not perfection” landscape.

We expect periods of upside momentum during which “FOMO” (fear of missing out) drives stocks higher to be followed by periods when catalysts emerge that allow some profit taking without FOMO. Such pauses are likely to be followed by periodic rotation and rebalancing, much as has been the case over the nearly 11 years that this bull market has run.