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The Brave Report: Market Commentary for January 2020

For .pdf version of this report click here: The Brave Report-January 2020

Hey Santa Clause, Hey Santa Clause… A December Santa Clause rally capped off one of the best years we have seen in a while. Markets surged throughout the month to close the year just off all-time highs. While some were looking for some profit-taking after the great year we had already had, the markets seemed to just continue to march higher as many of the risks and uncertainties that were present throughout the year moved to the sidelines.  We now enter a new year with several factors to consider.  Does this rally still have legs? What risks or uncertainties will move back to the forefront? And how will the election shape market performance throughout the year?  While few expect a repeat of what we saw in 2019, barring any major shocks to the system, the fundamentals are in place for positive performance to continue.

Market Overview

All major indices climbed steadily throughout the month.  The Dow Industrials and the S&P 500 both notched gains of around 3% while the NASDAQ surged another 4.9%.  This puts the year-end totals at 22.3% for the Dow, 28.9% for the S&P and 35.2% for the NASDAQ.  This marks the best year all the indices have had since 2013 and the 2nd best annual performance in the last 22 years.  This is a far cry from where we were to end the year last year when the market lost close to 20% in the 4th quarter.  While I expect to see some profit-taking or a small pullback at some point early this year, the uncertainties that bogged us down in recent years seem to have abated.

On the fixed-income side, rates continue to be relatively range-bound. The rate on the 10-year continued to trade in the same range it has traded in since mid-October.  With no surprises expected from the Fed, and barring any major shock, I expect this range to hold on the short term.  However, if we look back at the whole year, the 10-year is trading almost a whole percentage point lower than it was a year ago.

Year-End Review: Coming into the year there was a lot of fear in the markets and there were a number of uncertainties that were elevating risks in the markets.  Trade tensions with China were intensifying, there was disagreement around what the Fed should be doing, and fears of a global recession were increasing.  We also saw a major 4th quarter selloff to end the year that had many investors feeling very uncomfortable.  While fundamentals seemed strong in 2018, these uncertainties were holding things back heading into 2019. The performance we saw during the year can be attributed to the fundamentals continuing to surprise to the upside while these uncertainties, in turn, slowly abated. The uncertainties had held the market back in 2018 so with these risks diminished, stocks were able to realize the fundamentals of both 2018 and 2019 over the last 12 months.

The biggest uncertainty of the year was the trade negotiations with China. The success or failure of these negotiations would have a major impact on global growth and could lead to or prevent a global recession.  While we saw a few escalations in rhetoric throughout the year the general trend has been positive, and it seems steps are being taken to eventually reach some sort of deal.  A “phase one” deal looks to be signed in the next few weeks which has helped to move this uncertainty from the forefront of discussion, but I expect we will revisit this issue throughout the year. Only time will tell if we can reach a substantive deal that actually has a positive economic outcome for the US economy but at this time investors feel like we are making progress and that is enough to quell fears.

Entering the year there was also some great disagreement around what the Fed should be doing.  Many were calling for several rate cuts and that is exactly what we got. While some, including the President, wanted more drastic cuts, the markets have reacted positively to the role of the Fed this year.  More than anything, the Fed has been much clearer about its projections for future cuts or hikes over the last few meetings.  This has helped to dispel uncertainties around their next move and removed the fear of any surprises coming from Powell.

Lastly, there were points in the year where every pundit was screaming that a global recession was coming.  Every indicator they referenced seemed to be predicting the end of growth.  What we have seen so far is that these fears were very unwarranted. I am not saying that we can’t fall into a recession sometime over the next few years but so far these pundits have been very wrong. Domestic growth continues to surprise to the upside and if we continue to see progress on the trade front then the global economy should continue to see growth

2020 Outlook: With the Goldilocks market we have seen over the past year, where are we going to go next? The market has run pretty far over a relatively short time and some sectors are in oversold territory. With that said we aren’t close to a euphoric state that often precedes a massive sell-off. In the short term, I expect to see some consolidation or a small pullback before we continue a move higher.  I am not expecting another 28% year but with a lot of the market uncertainties removed the market should be able to continue to focus on fundamentals and move higher.

With that said there are some uncertainties that could derail this continued growth.  Geo-political issues always seem to rear their ugly heads when there is nothing else going on.  Recent tension in the middle east is a perfect example of this.  It is still too early to see what materializes but geopolitical fears do tend to have a short-term negative impact on markets, but the markets typically recover relatively quickly.

Domestic politics will also be at the forefront as we work our way through an election year.  The impeachment process will be piled on top of this. Both issues could cause markets to take a more muted view until the election outcome is clearer. Historically, election years tend to be positive for the markets. Since 1929 there have been 23 elections and the markets have only been negative during 4 of those election years. However, during the 2008 election years markets lost around 37% so it isn’t always a rosy picture. I predict that the election will be a reoccurring topic in these reports throughout the year but at this point, we do not know if it will be a negative or positive catalyst.

Lastly, with trade negotiations moved to the background for now, it would be foolish to not expect continued discussion to be a major market driver moving forward.  I expect the President to continue to publicize wins on the trade front throughout the year as he looks to strengthen his election prospects but, as we have seen in the past, any deterioration on the front can lead to a quick and sharp selloff.

With all these risks considered, I still have a positive outlook on the markets and the economy for 2020. With many uncertainties removed, I expect corporate spending to increase and this should help to continue to deliver positive corporate and economic results. With more predictability on the trade front and from the Fed, we should see growth continue.

Strategy Commentary

I continue to maintain the same equity allocation.  We did see some progress on the trade front, with a phase one agreement ready to be signed this month but with the run we the market had to end the year I am comfortable waiting for some consolidation before adding to any positions. Last year we were able to do some year-end tax-loss harvesting but with across the board positive performance, we didn’t do any selling into year-end.

On the domestic side, I am maintaining my overweight to technology, financials and industrials. With trade tensions easing and a more stable rate picture, I expect these sectors to continue to outperform.

I am maintaining my current outlook on international markets.  I continue to hold my Japan position and will continue to add to some other Asian markets, specifically China, as trade progress is made.  China had a strong end of the year, but I still think it has room to run as trade worries really held performance back over the last two years.

I am maintaining my neutral stance on fixed income.  With little action expected from the Fed we shouldn’t see any major shocks to the fixed income space.  However, if trade negotiations do deteriorate or we see any geopolitical escalations, we could see a short-term rush to safety that would put some downward pressure on rates. I am still favoring the short end of the curve but am not looking to add to any positions right now.

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