All major asset classes and sectors were in positive territory for the quarter and the year. Investors appeared to overlook trade wars, Brexit, slowing global growth, earnings pressures, and finally the U.S. President impeachment. In the fourth quarter equity markets, looked past all of the noise to project that 2020 earnings will be incrementally better and that we will see higher global growth. The S&P 500 (U.S. large cap stocks) was the top performer with over 31% returns for the year, followed by the Russell MidCap index and the Russell 2000 (Small Cap) index.[i] International stocks as measured by the EAFE index was up 22% and the Emerging Market index was up over 18%.[ii]
Furthermore, accommodative global central banks provided liquidity and reduced interest rates.[iii] Internationally, much of Europe and Japan continued to face negative interest rates.[iv] In the U.S., the Fed reducing interest rates allowed for a slightly inverted yield curve to steepened.[v] Over the course of the year, the 10-year U.S. Treasury bond yield went from 2.7% to 1.4%, and back to 1.9%.[vi] With yields on the way down for most of the year, longer dated bonds saw double digit returns. The Barclays US Aggregate index was up over 8%.[vii]
Even commodities had a positive showing with gold and oil up during the quarter and year.[viii]
U.S. Equity Markets and Economy
The U.S. equity markets continued their yearlong rally into the fourth quarter with many indices and sectors closing at new highs. Technology companies led the way with Microsoft, and Apple both eclipsing the $1 trillion market cap level.[i] The NASDAQ index, which is heavily technology focused, reached new highs, and had the best performance since 1999.[ii] However, in the fourth quarter as markets looked ahead towards improving 2020 earnings and a better global economic environment, we observed a rotation to the more cyclical financial and industrial sectors. The only sector that significantly lagged was energy, despite the price of oil increasing to $60 per a barrel, up 30% from the start of the year.[iii]
The U.S. economy continues to be positive in the fourth quarter as employment numbers remained strong, consumer spending was robust, and housing numbers increased. The U.S. consumer driving 70% of the GDP is helping with the expansion story.[iv] Manufacturing has been impacted by the U.S. and China trade war. This is evidenced by the Purchasing Managers Index (PMI) entering contraction territory in China and close to contraction in the U.S., which more recently has started to turn positive.[v] It appears that the U.S. and China have reached a Phase One deal which prevents additional tariffs and helps facilitate some trade of agriculture products.[vi] U.S. CEO’s have been uncertain about the trade talk progress and it is estimated that if the investment withheld in 2019 is invested in U.S. companies in 2020, it could add 0.5% to GDP growth.[xv]
Over the course of the last two years, the U.S./China trade war has been a constant back and forth between the two nations; with expectations of a much needed trade deal and then deflation when a deal felt like it would never come through. It has been impactful to China’s economy as exports to the U.S. have declined, the China PMI went into contraction territory, consumer spending pulled back and GDP growth gradually declined to 6%.[i] A Phase One trade deal was announced in the fourth quarter, and the deal will be signed in January 2020.[ii] Furthermore, China has been facing its own deliberate resetting of the economy by the central government to reduce the high debt levels and on-going large scale stimulus measures. We expect that China is maturing into a large global economy. As the trade war subsides, we believe that there will be an incremental improvement in manufacturing and re-stocking of inventory, which should be beneficial to China and other countries around the globe. As a result, Chinese stocks were positive for the quarter.[iii]
The main topic in the fourth quarter was Brexit and the new prime minister election in the U.K. Boris Johnson had taken over as prime minister from Theresa May in July after she failed to get approval for her Brexit deal.[iv] Johnson too had trouble getting approval from Parliament, mainly around the movement of goods between Northern Ireland and the Republic of Ireland.[v] Johnson called for a snap election and won the election, supporting his Brexit deal.[vi] Currently, the official timeline to leave the European Union is January 31, 2020 with a transition period through the rest of the year.[vii]
France is facing protests internally as the country to moving to a retirement saving system similar to the U.S. 401K program.[viii] As the government attempts to move towards a more self-supporting retirement system there is a lot of resistance.[ix] Paris, itself, is facing real estate pressures as financial firms move their employees from London to Paris due to Brexit, which in turn is causing renters in the city to move.[x]
After countries like Germany came close to a recession, it appears that the equity markets turned positive in the belief that growth will improve and the European Central Bank (ECB) will continue to provide liquidity support.
Interest Rates/Fed/Fixed Income
The Federal Reserve (Fed) cut interest rates for the third time in 2019 with the latest cut in October.[xi] The interest rate yield curve had inverted in June, with the two-year yield higher than the ten-year yield, which often portends a future recession.[xii] To prevent a recession and slowing economy, the Fed quickly acted to cut rates.[xiii] Currently, there are opposing expectations for another Fed rate cut or if the economy does improve the potential to increase rates late next year. The Fed has also stepped into facilitate the repo market. In addition to buying short-term treasuries to ensure there is enough liquidity in the market, it is now increasing its balance sheet.[xiv]
With fixed income yields so low and the spreads between corporate bonds and treasuries narrow, we view equities as being more attractive than bonds.[xv] We are uncertain about the direction of interest rates, although we believe they could move a bit higher, but be relatively range-bound.
The West Texas Intermediate crude oil price increased 13% for the quarter as the U.S./China trade war simmers down and China’s demand for oil stabilizes along with deeper than expected oil production cuts by OPEC in December.[xvi] This has led to an oil price over $65/barrel and up over 35% in 2019.[xvii] Investors are getting more interested in energy as conditions look positive going into 2020.
During the fourth quarter, Saudi Arabia finally sold shares of its state-owned oil monopoly, Saudi Aramco, in an initial public offering, creating the largest public company by market capitalization at over $1.7 trillion.[xviii] This is the largest publicly traded company in the world by market capitalization. Saudi Arabia is attempting to diversify its holdings and create an economy more sustaining than oil related enterprises.
The U.S. Dollar had been appreciating for much of 2019, but started to decline during the fourth quarter.[xix] The appreciating U.S. dollar has been a headwind for emerging markets and U.S. companies, so a weaker dollar, if it continues, will be welcome to many market participants.
It was expected to be a record-breaking year for Initial Public Offerings (IPOs) with some high profile companies going public like Uber, Lyft, and WeWork.[xx] However, investors balked at the overblown valuations, lack of profits and corporate governance concerns. Of the companies that went public, most are trading far below their last private valuations and pre-IPO expectations of where they might be priced.[xxi] In the end, investors were willing to pay up for companies with profits and had less enthusiasm for those without.[xxii] Over 211 companies went public in 2019 raising $62.33 billion, which is well below 199’s record of nearly $108 billion raised.[xxiii] 2020 is expected to busy with IPOs, but with smaller or lesser known companies. The lone big tech name is Airbnb, which is likely to pursue a direct listing, in which it would start trading directly but would not raise money.[xxiv]
Top Themes for the Next Decade
- Change in Globalization
- Over the last few years, we have seen countries move away from globalization and become more nationalistic. Brexit in the U.K. was about breaking from the European Union (EU) and the UK protecting its own trade interests as well as flow of immigrants.[xxv] Under President Trump, the U.S. has actively engaged in rewriting trade agreements, while implementing tariffs, with Mexico, EU and China[xxvi]. China has also become more protectionistic. Over the year, we have seen a move towards controlling Hong Kong and the resulting protests, the increasing use of citizen surveillance, and the movement of Made in China 2025.[xxvii]
- In general, we do not think there is an end to globalization, but there is a shift in what countries expect the relationships will be going forward and rewriting trade deals that make more sense given current dynamics. This shift is impactful to supply chains as well as the end consumer, so we are watching it carefully to understand the top and bottom line impacts.
- Income Inequality
- The level of inequality is usually measured between the earnings of the top 1% of a countries population and the bottom 1%. In English speaking countries, like the U.S. and U.K., that measure has reached levels not seen since the 1980’s. Many like to point to globalization and technology contributing to inequality, but an IMF study shows that technology is contributing to most of the disparity. However, without technology we would all be worse off. With social media, the emphasis of this disparity is more pronounced.[xxviii] With the U.S. election year upon us, we will see more in the news about this issue and related issues like CEO compensation, stock buybacks, and leverage.
- Change in Transportation and Logistics
- 2019 was the year that ride-sharing companies, Uber and Lyft, went public, but we learned that both companies continue to lose money as they build out fleet management, autonomous vehicles, and logistics businesses.[xxix] Both companies believe that they will control all aspects on car ownership and transportation at some point. The question will be will anyone actually own cars in the future?
- Electrification of vehicles. China is pushing for more electric vehicles and has a stated goal of 1 in 4 cars sold by 2025 need to be electric. Currently, only 5% of all vehicles sold in China are electric. For a while, China was subsidizing electric vehicles, but has cut out those subsidies, which may need to be absorbed by car companies.[xxx] In Europe, new emission standards have gone into place for 2020, with very few car companies in compliance. The number of people purchasing electric cars in Europe is growing, but is still relatively small compared to total car sales. New regulations can change that.[xxxi]
- Climate change
- Climate change came front and center in 2019 with the help of 16 year old Swedish activist, Greta Thunberg, who staged weekly protests at her school and received global attention for her activism, with millions of people staging their own protests. The challenge is that the issue is divisive with some countries very focused on it while others, like the U.S., are resistant to taking action. The EU released a plan for its 28 member countries to become climate neutral by 2050 and China is transitioning to renewable energy and electric vehicles.[xxxii] This topic will continue to be of interest and what will the U.S. do around this issue, but we are also exploring companies that provide renewable energy or source electric vehicles.
- Plant based foods and healthy eating
- One of the hottest IPOs in 2019 was Beyond Meat, a meat based alternative.[xxxiii] As people are moving away from meat based diets to plant based diets, companies like Beyond Meat and Impossible Burger have sprung up to provide a plant based burger or meatball. Vegetarian, salad based or healthier food options are on the rise. Sweet Greens, with over 100 locations in the U.S., sells salads and has over a $1 billion valuation.[xxxiv] Another interesting start-up is Farmer’s Fridge, which operates vending machines with healthy options like salads and bowls. With more attention on healthly eating we expect that this trend will continue to grow.
- Experience based economy
- In recent years, consumers are increasingly shifting towards spending on experiences versus buying actual goods. Spending on experience related services has grown 4 times faster than expenditures on goods. Consumers of all ages are opting for experiences, with millennials leading the charge. Three key factors are driving the shift in consumer spending behavior: a holistic perspective on what leads to happiness, the growing importance of social media, and an increasing fear of missing out.[xxxv] These changes are significantly impacting retailers, the experiences they offer and how to capture these dollars.
- Artificial Intelligence (AI)/Machine Learning (ML)
- AI/ML continues to grow and be embedded in many companies as they figure out how to use customer data to improve decision making, improve outcomes and target information. We see AI/ML being used in almost every business from retailers analyzing consumer spending patterns and targeting advertising, to insurance and banks refining underwriting standards to human resource departments sorting through electronic resumes.[xxxvi] Anywhere there is data and patterns, AI/ML can be used. We expect AI/ML to continue to help with efficiencies, improving processes and reducing overall costs. It also means that job skills are shifting.
- Fintech also continues to grow rapidly and can mean many different things. On the payment side we have seen disruption with Stripe and Square, which has resulted in some big players like Fiserv acquiring First Data (which owns Clover). Everyone wants to be a bank with tech firms like Apple Google and Facebook offering financial services. Fintech start-ups like Acorn, Betterment and Dave launched checking accounts. Then you have some big players wanting to be in cryptocurrencies like Fidelity, Facebook and JP Morgan. The space is changing quickly and has broad implications for a variety of industries that we cover.[xxxvii]
- As of January 1, the California Consumer Privacy Act (CCPA) is in effect, which means that companies that operate in California must disclose whether it collects individual data, how it is used and if it is sold to third parties. Individuals also have the right to opt-out of data collection.[xxxviii] This is a significant change and it will be interesting to see the impact to large tech firms like Google and Facebook. It also means that similar laws will be enacted in other states.
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