Looking back over 2019 from this vantage point feels pretty invigorating. It was a very strong year for returns – with even conservative asset allocations without a lot of stock exposure performing quite well.
However, if we turn the clock back to the beginning of 2019, there weren’t too many rosy forecasts – despite the fact that, as we said at the onset, the third year of a presidential cycle is historically the strongest. Even with that fact, and other tailwinds in place, the impressive returns of 2019 were unexpected by most. Why?
Well, to start with, the fourth quarter of 2018 hit the world markets very hard, and many investors took their money out of equities and bonds. Outflows from funds (mutual and exchange traded) were massive following a short period of significant negative returns. Despite a huge year in 2019, the money has only now started to come back in – potentially due to a fear of having missed out. This has pushed markets even higher at the start of this year.
This is why having a disciplined process – one that emotional responses cannot override – is key to smart investing. It makes total sense on an emotional level to move your hand from the heat source when you get burned, and that’s what investors did throughout and following the last quarter of 2018, but those who were able to overcome that instinct and chose not to react were the big winners in 2019.
Since we know that forecasts are rarely worth the paper they’re printed on, trying to guess where the market is going to go for the next 12 months isn’t something we strive for. Instead, we prefer to look at the past, and the environment we’re in, and apply our process to what we know right now.
With that, here are our four adages to invest by in 2020, a unique year that will be as unpredictable as any before and any after.
1. Ride the Wave
Markets around the world are on an upward trajectory, continuing to grow powerfully. Even though there are some aspects of current market conditions that are not quite as attractive, for now at least, things keep going up.
As an investor, when you see the tide coming in, ride it.
You may see a storm on the horizon, and some potentially dangerous breaks in the distance, but if the wave in front of you is strong, take advantage of it.
2. Don’t Fight The Fed
Central banks around the world have been making changes and impacting markets heavily long before, but especially since the Great Recession. Interest rates, and the liquidity they can either create or deplete, influence the behaviour of businesses and economic conditions, and of course the markets themselves.
In 2018, the Federal Reserve and other central banks around the world were slowly starting to raise interest rates. We saw three rate cuts in 2019 with the final cut occuring on December 31. Now more than 80% of central banks are easing interest rates. All of these actions added, and continue to add, fuel to the fire that started growing in the last quarter of 2019.
Historically, the third rate cut is correlated with favorable performance in the S&P 500, and lower interest rates have typically led to an increase in liquidity for global manufacturers, which leads to an increase in manufacturing, which in itself has a decent correlation with market growth.
At some point, of course, all that stimulus provided by those rate changes starts to fade. For the moment however, central banks around the globe have been accommodative and associated economies have responded. While recession risks are still high, central banks are unlikely to get aggressive about raising interest rates without some inflationary pressure.
As investors, we don’t see any reasons to fight the action that central banks and the Federal Reserve are taking. They’re still in stimulus mode and we’re still reaping the related rewards.
3. Don’t Fight Fiscal Policy
This may look like the same adage as the one above, but fiscal policy differs from the actions of central banks. Changes in fiscal policy are the actions the government takes, such as the tax cuts we saw in 2017, that can make it easier or more difficult for companies to do business. That 2017 tax change was structured in such a way that businesses which were holding their cash overseas were able to bring it back to the U.S. at a much lower tax rate than before – and they did. But what did they do with that money?
We saw a huge increase in corporations buying back their own stock, adding inflows to the market that were moving in the opposite direction from investors, who were leaving the market in droves in late 2018 and have only just started to return. Despite this outward fund flow, the market rallied powerfully (thanks to this influx from corporations) and many are kicking themselves for having missed out.
Another fiscal positive for the country is the deal with Canada and Mexico, which actually amounts to double the amount of trade value versus the ongoing, much-publicized trade discussions with China. Congress passing the USMCA creates a greater balance of trade for U.S. companies.
Despite any other challenges associated with the current presidency, the policies that have been implemented have been stimulative to the economy and paid off well.
If governments are taking actions that increase the potential earnings of companies that drive our economy and our stock markets, you’ll want to be on the right side of that as well.
4. Be Wary of Extremes
Any kind of extreme in either optimism or pessimism is worth being careful about. It can be very profitable when you manage to correctly identify the extremity and the right actions to take during those moments.
Over the last 15 years or so when optimism was in extreme territory, the ensuing average annual returns ended up actually being negative. Conversely, when pessimism was extreme, the performance that followed went in the opposite direction (up). Many would not expect to hear that only 5-6% of indicators were demonstrating bullish sentiment at the start of 2019 – but such was the case – and it proved to be an incredible entry point into the market!
I should point out that the bulk of gains, when things are that pessimistic, are typically made in equities.
Today, even though the tape is strong, policy is positive, and the Fed is accommodative, we do have a little problem on a short term basis. The optimism camp is extreme, and some complacency has started to build up. Over the long term, returns in the S&P 500 tend to be muted with this many people feeling euphoric. Stay tuned.
– Greg Stewart, CIO