We see a number of macro themes acting on markets in the coming year:
- The policies of major central banks, including the U.S. Federal Reserve, the European Central Bank, the Bank of Japan, the People’s Bank of China, and others, are supportive of global stock markets;
- A new president of the European Union, Ursula von der Leyen, is proposing big fiscal policies for green tech, subsidies for battery production, and electric vehicle transit — all of which are good for the economy of the Eurozone;
- Emerging-market countries are improving, but not great as a group.
- Politically, oil stocks are under attack, and many institutions are disgorging their positions — so although oil is fine, and oil shares may rally for a few months, they have longer-term problems. We believe commodities will rise somewhat in 2020. Lithium and gold may be exceptions, and could rise more.
- The U.K. has been set free to grow by leaving the European Union. We have been bullish on the U.K. and remain bullish.
Europe
Europe can do better, thanks to more capital spending and policy focused on green tech investment, especially batteries. Europe will also become more entrepreneurial if President von der Leyen gets her way.
The U.K.
- The U.K. will do much better due to increased capital spending.
- London is secure in its status as the financial center of Europe.
- The people of the U.K. have shown themselves, in the recent Parliamentary elections, to be pro-growth.
- New fiscal spending plans from Boris Johnson and the Conservative Party is a platform much like the U.S., and will encourage growth.
- Soon, the U.K. will have a new trade deal with the U.S.
- Europe and the U.K. will both be helped as their currencies strengthen against the U.S. dollar and against emerging-market currencies.
The Federal Reserve
- Current inflation and expected future inflation drive Fed policy;
- Fed policy determines the availability of money;
- The amount of money available from credit and equity drives economic growth;
- The economy determines the rate of GDP growth, and inflation determines which sectors of the market attract money.
The Fed has said (explicitly, through Chairman Powell) that they intend to remain on the sidelines for the foreseeable future. They will wait for an actual increase in inflation, rather than the fear of inflation (such as the experience of 2011 and 2018, when markets fell as the Fed reacted to a merely possible, but not actual, rise in inflation). This time, the Fed has stated that they will tolerate a rate of inflation in excess of 2% (as measured by growth in core personal consumption expenditures, or PCE) for a period of time before determining that inflation is resurging. Today, the Fed’s favorite inflation measure shows inflation at about 1.7% as measured by core PCE.
Productivity is rising, as evidenced by recent economic data. Trade conflict and general increases in labor costs have had two effects: more automation, and the hiring of more engineers or employees with computer skills for factory work. The result: higher pay for factory workers, and fewer of them. Higher productivity means lower inflation and a longer economic recovery.
The Fed has changed its strategy — trying to achieve core inflation of 2% or higher for some time before raising rates. Currently, unemployment is very low, but there are still many workers who have been unemployed long-term — which means that the workforce can expand as long-term unemployed re-enter, and unemployment can go lower.
The consumer is strong. Chairman Powell has stated that he would raise rates only if inflation went meaningfully above 2% for a period of time. Many Fed officials have recently stated that lower inflation is the real risk in the current era.
Currently, the five-year forward breakeven inflation rate employed by the Fed is 1.7%, well below 2%. It is quite possible that the Fed will not raise rates for a substantial period of time, and stocks can continue to go higher.
Other Positives
- Phase One China deal;
- Trade agreement with Canada and Mexico (the USMCA);
- U.S. GDP up 2.0% in the third quarter of 2019, 2.1% in the fourth quarter, and up also in 2020 many economists are estimating 2% growth in 2020.
Gold and Commodities
Low inflation is not good for gold, or for commodities in general; however:
- Gold can benefit from international tensions (e.g., North Korea, China, Russia, Iran, and others);
- Gold can be in demand as a hedge against global debt levels;
- Increased demand for gold can come from emerging markets and energy-rich countries who see the price of the main product (energy) declining longer-term;
- Increased demand can come from the citizens of poorly managed economies which flirt with or engage in disastrous economic policy (e.g., Argentina, Venezuela, Mexico, Iran, Iraq, Russia, or African nations);
- Gold, along with all other commodities, can benefit from recent U.S.-dollar weakness.
The U.S. dollar may move slightly lower, which would attract money to areas where the currency is rising versus the dollar (e.g., the U.K. and Europe).
Oil and commodities will rally if the U.S. dollar is weak; gold will be benefitted if commodities are stronger.
Summary
Our favorite markets, sectors, and industries in 2020:
U.S.: Technology and healthcare; software, cloud, electric vehicles. U.S. energy for a trade of a few weeks or months.
U.K.: All industries, especially homebuilders and financials; small- and mid-sized firms.
Europe: Well-managed northern European economies (Germany, the Netherlands, Sweden, Ireland).
Gold: For a steady move up to $1,600.
Concerns in 2020
A move up in U.S. rates would be modestly risky for long-term debt instruments. When U.S. 10-year rates went over 3% in the last decade, it has resulted in U.S. market corrections of 20%. U.S. 10-year interest rates as of this writing are at 1.93%. Most analysts expect U.S. 10-year rates between 1.5% and 2.25% in 2020.
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