Vigilare Wealth Management Q4 2019 Commentary

By Jason@vigilarewealth.com on January 10, 2020 in Investor Lounge

The equity markets closed the year in full Santa-rally mode with all major global indices posting double digit returns in 2019.  It was a year where a relentless cacophony of economic and political headline risks overshadowed a somewhat steady U.S. economy.

Our sanguine outlook for 2019 turned out to be so. Early in the year we highlighted the following as catalysts for a strong 2019 rebound year:

• Resilient U.S. consumer, especially in the lower to middle income tiers. Wages grew overall in 2019 with the bottom 25% of wage earners growing at well over 4%. Geopolitical and headline risks did not impact consumer confidence (shockingly) which remained at high levels. The 2018 income tax reform also had a positive impact on middle to lower income tiers.
• Fed policy reverses to a more accommodative stance. Despite most market strategists anticipating more rate increases in 2019, we forecasted the opposite. This clue came to us early in 2019 when Fed Chairman Powell, in a forum setting with former Fed Chairs Bernanke and Yellen, hinted at changing course. This all came to fruition throughout the year with several rate cuts and an expansion of the Fed balance sheet (balance sheet expansion is hardly mentioned in the media, but we feel it is very significant).
• Market pressures could induce a cease fire and/or trade agreement with China. This was touch and go through the year and heading into the end of the year it appears that there is a truce or a “light” deal to start the new year. This is certainly not resolved, but a de-escalation from earlier in 2019 and ameliorates some uncertainty.
• U.S Federal deficit spending at a trillion a year. Government is again projected to spend over $4.5 trillion of which over a $1 trillion is being borrowed. With the cover of low interest rates, this provided (and continues to) a backstop to the economy and GDP.

Our outlook was not however conventional wisdom at the time of the original writing (January 2019). Many Wall Street strategists were bearish to start the year, as was investor sentiment which was at the low end of the historical optimism range. For example, we have referenced the exodus out of equity funds and ETFs throughout the year. According to Lipper, 2019 ended up being a record year in outflows away from U.S. equity funds and ETFs (dating back to 1992 when they started tracking this data). Conversely, U.S. bond funds and ETFs had the best year of positive flows in 11 years.

What does this all mean? As we transition into the new calendar year, we still observe a continuation of these positive factors mentioned above. The difference is that today the consensus is much more in line with these observations, as are the equity markets levels. Interestingly, peeking into recent data does show a turnaround in U.S. equity ETF fund flows, starting to turn positive in mid-December of 2019. There could be some frothiness in the markets. Market valuations are near the high end of the historical range which means to us that negative surprises could have a sharper negative impact in the near term relative to positive surprises (having a positive impact).

Here are some negative surprises we feel are not being priced into the market at this time:

• Earnings disappoint. Markets charged higher in 2019 without any growth in earnings (Seriously). Moving forward we expect the market to be more discriminating. We will keep a close eye on earnings across the different sectors of the market especially in the more cyclical sectors.
• Next up on the trade war list – Continental Europe. We think the next logical step in the U.S. trade policy playbook is to aim the tariff cannons towards Europe; Germany and France in particular. Why nobody is talking about this is surprising. With North America, Japan, South Korea, and China part 1 negotiated we would not be surprised if the US. administration initiates this tariff front as early as Q1.
• Manufacturing does not recover – Manufacturing and business investment has been stagnant and in decline throughout 2019. Trade uncertainty and also the 737-Max grounding/crisis (yes, it is that big a part of manufacturing) look like obvious reasons, but if we continue to observe a decline in these data sets it could start to spill over to the rest of the economy.

These risks could end up being temporary even if they do materialize. We view these as short-term and early year risks. As always, we will be vigilant, especially if we see our recession indicators elevate (not happening at the time of this writing). Having an economic environment with low interest rates, low inflation, strong employment, healthy government spending, a friendly Federal Reserve, a strong consumer and some trade certainty (ex. Europe) are all positives which could propel GDP higher in 2020 and ultimately the stock market.

We are in a general election year (duh, right?) and markets are generally fickle in election years (2000, 2008, 2016, etc.) We expect continued headline volatility throughout the election process. We have said it time and time again to the point where is sounds cliché, but markets do not like a backdrop of uncertainty, and we do expect volatility to pick up as we get closer to November. We are however still a few quarters away from the election. We will have more to say about this as we get closer to November.

We look forward to a new year and new decade.

Thank you for your trust.

The Vigilare Wealth Management Team

P.S. New legislation in the form of the Secure Act signed recently will have an impact on some retirement planning decision making. We will discuss this individually as it pertains to your situation. 

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