Over the past few months, the markets have slowly moved higher, and some of the earlier clouds have parted (i.e., trade friction and the inverted yield curve have both improved.) Even Brexit looks like it will finally proceed.
And while we try not to bring out too many investment cliches, one that fits 2019 is "Don't fight the Fed." The Federal Reserve has made sure that trade issues haven't harmed the US economy too much, and it has reduced its benchmark interest rate on several occasions this year. This has underpinned a rising market.
The Fed stands ready to react to any signs of weakness, although they have signaled that no more reductions are imminent.
As we look to 2020, we won't try to handicap the elections, but they surely will be a factor in investor attitudes, with a likely higher level of volatility. Let's weigh the other major issues:
POSITIVE - Corporate earnings growth for the coming year is always a wild card. The average S&P500 company grew its earnings by more than 6% in the third quarter, and
expectations are presently for a modest decline in Q4 before a re-acceleration next year.
NEGATIVE - Stock market valuations are excessive, with the S&P500 P/E at nearly 25x. As the graph above shows, total stock market value has seldom been this high versus the
size of the economy. Our worry is that future returns from extreme valuations have usually been sub par.
POSITIVE - Interest rates are likely to remain low in an environment of muted inflation.
POSITIVE - Corporate profitability is likely to remain high. Companies have been cautious about expanding as the economic cycle has matured.
NEGATIVE - Companies haven't been shy about adding debt, and the Federal government's deficits are excessive for non-recessionary periods. Individuals have also been
taking on more debt as wage growth has remained stagnant. All of these will magnify any downturn.
With the balance of market factors weighing on the positive side in the short term, we're inclined to maintain our current exposure to US equities. The major economies of Europe and Japan remain weak, offsetting the more attractive valuations of stocks in these regions, so we remain underweight these markets. Emerging countries might get a reprieve with an improving trade picture, and we have just begun adding to those positions.
On the fixed income side, we find little of interest (no pun intended) with minuscule yields being paid on quality debt instruments. High yield debt spreads (versus Treasury notes) are
also low versus history, meaning that one must be particularly careful in choosing specific investment vehicles.
In the private markets, we like the fundamentals of affordable housing, which has far less cyclicality than typical multi-family real estate, along with attractive cash flows. Farmland, especially organic, continues to have long term appeal. And renewable energy partnerships are a cash generating asset that can deliver attractive total returns with positive social impact.
A WORD OF THANKS
As we head into year end, we'd like to thank our clients and friends for their support in 2019, and we wish each of you a safe and happy Christmas Season.
As we have done for the past decade, Boardwalk Capital has made contributions to several charities in honor of our clients and friends. This year, we have chosen Heifer International and the Atlanta Community Food Bank. Be sure to visit www.heifer.org and www.acfb.org to learn more about these wonderful organizations.