2019 – Tales of the unexpected
At the beginning of the year share markets were under extreme pressure as tightening monetary conditions and trade disputes imperilled growth, and investor sentiment. Crude oil and copper prices languished at two-year lows. The US ten-year bond yield sat at 2.80%. Both institutional and individual investor cash balances were high.
The big shift came in January. In globally co-ordinated actions, central banks shifted their stance from tightening/neutral to neutral/easing. Market reactions sparked a massive influx of cash. Share markets rose, both industrial and precious metals firmed, and the US ten-year bond yield started a decline that saw it almost halve.
The first half of calendar 2019 brought support for all asset prices, and especially growth exposures. The second half was trickier. After significant interest rate reductions around the world, central banks went to “wait and see”. This meant every growth related economic release, from GDP to company earnings reports, had traders speculating about the impact on valuations versus potential central bank responses.
Predicting market reactions to news became doubly hard. Would investors respond to a weaker China GDP release or non-farm payrolls number by selling shares because of the negative impact on profits, or would they buy shares in anticipation that the People’s Bank of China and the US Federal Reserve would leap to the rescue?
Further complications arose from the trade disputes the White House prosecuted against China, Japan, Canada, Mexico and Europe. British and European markets danced to a Brexit beat. In the third quarter headlines dripped doom, and the market consensus favoured a global recession in 2020.
Yet as the end of the year approaches, share markets are higher by double-digit percentages. Many hit all-time highs in the fourth quarter. Unexpected discipline from the OPEC plus cartel lifted oil prices more than 50% from their lows, and gold hit six-year highs.
The difference between public discussion and market performance has rarely been larger. This makes commentary on the year ahead both more difficult and less valued.
Forex – Remain calm
One of the key surprises of 2019 was the relative calm of foreign exchange markets. Volatility in major currencies remained closed to historic lows, with the honourable exception of the British Pound.
Despite protestations from the US, there was little evidence of currency manipulation. Weakening in the Chinese Yuan, and to a lesser extend the Brazilian and Argentinian currencies, largely reflected the circa 4% lift in the US dollar index over the year.
The aligned stances of central banks removed a key driver of forex market - interest rate differentials. The likely continuation of this co-ordinated stance suggests a similar 2020 for foreign exchange markets.
Commodity currencies like the Norwegian Kroner and the Australian, Canadian and New Zealand dollars could prove an exception. Despite the pick-up in underlying commodities, they are near multi-year lows against major currencies, and especially the US dollar. This may see a spring back in commodity currencies in 2020.
Gold and crypto currencies had exceptional years. Cryptocurrencies were highly volatile, offering extraordinary trading opportunities at significantly heightened risk. The uncertainty around the future of the blockchain-based currencies indicates this trading profile is likely to continue through 2020.
Gold outperformed other precious metals, rising from below US $1,300 to touch highs above $1,550. Although there is little to no threat of rising inflation, ongoing economic uncertainty and the ongoing support of reserve bankers could see another strong year for gold.
Share markets – buckle up
The outlook for shares is dimming. The positive outlook due to easier monetary conditions is offset by high share prices and stretched valuations. Unpredictable investor reactions to news as they second-guess policy responses adds to the difficulties.
A higher probability outcome for 2020 is that stocks will trade largely sideways with an upward bias. However the path could be even rockier than 2019, with large swings on the cards. Doubting the extremes of sentiment worked well in 2019, and could outperform in the coming year. Active investors may consider selling when conditions look terrific, and buying when conditions seem terrifying.
An important potential change in stocks in 2020 is a shift in the favoured investment style. In 2019 global investors chased growth at almost any price, driving stocks like Alphabet and Amazon to record levels, and supporting Initial Public Offerings from profitless companies like Uber. This is a fun party game, but the music may stop in 2020. In a fraught environment investors find buying stocks with lower share prices more attractive, and 2020 could be the year where value investing roars back into style.
Key drivers 2020
- The interplay of growth and monetary policy remains a top consideration for market performance. Growth prospects and central bank actions mean economic data and monetary policy announcements are pivotal in determining short term direction.
- Fiscal policy. As monetary policy approaches the “lower bound” its usefulness diminishes. This may see increased pressure on governments to push on fiscal levers to bolster economies. Infrastructure spend is an obvious area of support, but if conditions deteriorate more unconventional attempts at fiscal stimulus are possible.
- Elections. The Federal election in the USA in November is a major issue for global markets. Uncertainty surrounding the likely result, bruising campaigns and the rise of populism could swing markets over the course of the year. New Zealand also faces a general election in November. The current coalition government face challenges, and policy announcements from major parties could drive stocks, sectors and the New Zealand dollar.
- Economic lunacy part 1 – trade disputes. The economics of global trade disputes are clear. Nobody wins in a trade war. The issue for markets is that the politics of trade disputes are much murkier, and the incumbent US President may see opportunities to play to a domestic political audience. An increasingly popular view is that full resolution is unlikely before the November elections.
- Economic lunacy part 2 – the potential for swings to strongly negative sentiment, and the limits of conventional monetary policy, means there is potential for economic stupidity. An example is the serious discussion in some circles of the so-called Modern Monetary Theory, perhaps more aptly known as money-printing or “Magic Pudding” monetary policy. The historic experience of the Weimar Republic, and the economic disaster in Zimbabwe this century, should be enough to shut down these discussions. However desperate times breed desperate measures, and investors may do well to recall the words of Friedrich Hegel: “The only thing we learn from history is that people learn nothing from history.”