On the (geo)political front, instability was certainly rife. 2019 saw Russia continue to extend its influence in the Middle East; Turkey move into Syria and shock its NATO partners by buying Russian defence material; the UK make a fool of itself in the process of exiting the EU; China be hard-pressed to keep the Hong Kong situation under control; and the US government punish all and everyone that President Trump could think of. And 2020 has just began on a very tense note in the Middle East, with the US killing of Iranian General Soleimani significantly increasing the odds of a regional conflict.
Climate change also figured high on the 2019 political agenda, especially in Europe, and deepening inequality between the “haves” and the “have-nots” pushed people onto the streets in several regions of the world, the “yellow vests” movement in France being a prime example.
Despite this not being an environment in which one would expect financial markets to rally, 2019 turned out to be one of their strongest years since the Great Financial Crisis. This impressive showing is mainly attributable to the Federal Reserve (Fed) U-turn early in the year, abandoning its path of monetary policy normalisation (i.e. interest rates hikes and balance sheet shrinkage). Under very high pressure from President Trump, the US central bank embarked on a series of rate cuts, with no apparent economic justification. The fact was simply that, with all other central banks still in very accommodative mode, the interest rate differential between the US and other major economic blocs threatened to push the US dollar even higher than it already was. For the US President, intent on bringing the US trade balance back to equilibrium, such a prospect was unacceptable – because detrimental to exports.
Overlooking the many longer-term negative side effects of (very) low interest rates, stock markets cheered this policy reversal. But while equities are the remaining investment category able to possibly generate positive real returns in the foreseeable future, their 2019 rally has brought them back to rather expensive territory, especially taking into account the extraordinarily high level of earnings on which current multiples are computed. Such exceptional earnings are mainly the product of a still growing (albeit slower) economy, with a very low cost of debt, relatively low wages and low(er) corporate taxes. Further, earnings per share are in many cases boosted by leveraged share buyback programs. In short, the picture can get no better.
Caution is thus warranted as we move into 2020, even though President Trump can be counted on to do whatever he deems necessary to keep the stock market humming at least until the November elections. This means more barking at the Fed Chairman to cut interest rates, compromises in the negotiations with China, and possibly even additional public spending – although the US budget deficit is approaching 5% of GDP and government debt exceeds 100% of GDP.
Closer to us, the European Central Bank has already pressed the accelerator pedal through the floor, with interest rates in negative territory and QE back in force. Its new President Lagarde is now also pleading for more public spending, especially in Northern European countries that have “low” public debt. The European Commission seems to no longer care much about member countries running higher than allowed deficits (France, Italy and Belgium to name but a few), so the road is paved for a new round of debt-driven stimulus.
We have little doubt that, sooner or later, all this will end in tears – just not yet. With new money inflows from pension funds and insurance companies (alongside freshly printed ECB liquidity), financial markets can be presumed to do well in the first months of the 2020. As we all know by now, thanks to data mining, pattern recognition and artificial intelligence, rising stock markets are the main reason for even higher stock prices – never mind valuations, macro-economic analysis, balance sheets or good sense. For now, investors can thus happily continue to enjoy the ride, but should not fall asleep at the wheel!
Happy New Year!
2019 In Numbers
A year ago, most investors – us included – were banking on a weaker US dollar, higher interest rates and equity returns in the single digits, i.e. positioned rather on the defensive side. Instead, 2019 brought about a flat greenback in trade-weighted terms (with even some appreciation between February and September), lower rates globally and quite exceptional equity returns.
Indeed, the MSCI World posted a 28.4% gain for the full year, led by the US (S&P 500 index up 31.5%). European equities followed suit, with the STOXX Europe 600 index gaining 27.8%. Japan and emerging markets were somewhat distanced (Nikkei 225 index up 20.7% and MSCI EM up 18.6%) but still delivered a remarkable performance.
As already mentioned, central banks – particularly the Fed – are to be credited for much of this equity rally. As the year came to a close, the conclusion of a "phase one” trade deal between the US and China, as per our expectations, and the dissipation of the prospect of a “hard” Brexit gave markets an additional boost.
Despite a relatively defensive positioning, our portfolios delivered good absolute returns in 2019. Not surprisingly, equities accounted for the bulk of their gains. Somewhat hurting performance were our long-held hedge fund positions, that did not manage to track the outstanding stock market gains, short dollar exposure as well as energy company holdings. We must say that the latter make for a particularly frustrating situation, since the oil price itself gained more than 30% for the year.