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| Markets have less baggage entering 2020 now that US-China trade tensions are clearing up |
Goodbye 2019, welcome 2020! January has been a crazy start for the year, with plenty of global newsworthy events passing on by with seemingly limited effect on the US stock market. After all, even after Friday’s steep slide, the S&P 500 is roughly flat for January.
The beginning of the monthly news cycle began with widespread coverage (some sensationalist) about US-Iran tensions and concern over massive bushfires engulfing Australia. Towards the middle of the month, we transitioned to fears over the spread of the new coronavirus out of Wuhan, China. Then, Kobe Bryant and his daughter perished in helicopter crash last weekend just days before the increasingly acrimonious relationship between England and the EU ended with Brexit.
On the final day of the month, stocks tanked as news stories decried the economic impact of a disease that is “certain” to slow down the world economy by shutting town Chinese tourism and shuttering Chinese industrial plants (please note there is a degree of exaggeration and sarcasm in this statement). Wow, all these events are enough to make anyone pause and do a double take.
What is the informed investor to do? How do geopolitical events, “global health emergencies”, or other uncertainty affect stock market investment decisions? Well, The Ignorant Investor – rationally ignorant, mind you, not blissfully or woefully uninformed – always recommends when stormy situations arise to take refuge in fundamentals. Once we’re certain of how things are going, and after taking into consideration the wisdom of Keynes*, we can better quantify the risk we’re facing and take calculated actions that result in solid wins even while navigating the swirling clouds of uncertainty. Today, let’s hit the pause button and break down what risks have the power to derail the stock market’s forward momentum.
A few January themes for February and beyond
1) The US stock market is richly valued. Following the S&P 500’s staggering 29% gain in 2019, the index is now valued highly relative to historical averages (ie this sometimes means that stock prices are higher on average than fundamentals warrant). With the market valued near perfection, any grey or black swan event can result in magnified stock market declines. In other words, the long-term risk reward ratio has changed so that there is higher risk relative to reward for the broader US stock market over an extended term than there was at the beginning of last year.
2) Global trade risks remain elevated. Over the last several years, the US has embarked on a policy of equalizing trade relationships with peer nations (while all agree this is necessary, what exactly that means and how to go about it is a matter of some dispute). While the US and China have embarked on a path towards normalizing ties, the Phase I trade deal remains tentative for the time being with considerable friction remaining about what enforcement mechanisms will be put in place in a final trade agreement to ensure that neither side will cheat in the future. Besides this, the US and EU have outstanding issues, some involving trade, others involving European taxation of US companies, that could result in tariffs is some amicable solution isn’t found in the near term.
3) Coronavirus' true effect on the global economy is unclear. China has moved quickly and efficiently following the discovery of the coronavirus to self-quarantine and take control of the contagion of the virus. Some effects of the virus on the global economy are very apparent. Countries have shut their borders to Chinese citizens. Airlines have refused to fly to China. Industrial plants and manufacturers have been forced to temporarily suspend operations within China.
The situation must be carefully monitored, but The Ignorant Investor suspects that the overall fear surrounding the virus is overblown, primarily because the fatality rate, hovering around 2%, remains relatively low. This makes the coronavirus quite serious, but hardly warranting the degree of fear and dread that was associated with the 2014 Ebola scare (70% fatality rate, WHO), or even the 2003 SARS epidemic (10%, WHO). For reference, in terms of total worldwide fatalities, the common flu will likely remain a much more formidable opponent. The Ignorant Investor will also note, based on patent filings, that one big biotech company that he has followed for many years may have even begun testing a drug that has the potential to treat illnesses associated with the coronavirus family as far back as 2016.
4) Political risks rise. President Trump is largely expected to be acquitted of impeachment charges by the Senate, but the race for the presidential election is now in full swing, with a number of potential candidates that desire to change the status quo of doing business in America for a variety of industries (yes, this is not a near-term risk but something to keep in mind for later in 2020). Political commentary may have an outsized effect on specific industries (*cough* healthcare *cough*) as the presidential race heats up.
Other stories of note
2019 is a tough act to follow. The S&P 500 rose an astounding 28% to historic levels from year end 2018 to year end 2019 (this ignores dividend reinvestment and other adjustments) while the Nasdaq rose more than 33% for the same period. Performance was remarkably strong across all sectors, with outperformance concentrated in technology, communications, and financials. The year’s challenges included soaring global trade tensions, yield curve inversions, and unexpected geopolitical events (Hong Kong protests). Rising to overcome these challenges were solid US fundamentals, a more accommodative Fed, and the semblance to a start of what may well become a US-China trade deal. The New York Times summarized earlier this month some arguments for why 2020’s stock market performance may be more subdued.
The ultra-exclusive Trillion Dollar club has arrived! In 2018, Apple became the first publicly traded company (in the United States) to pass the $1 trillion valuation mark. Since that time, markets have continued to increase, and multiples have expanded. Now, global publicly traded members include Saudi Aramco, Apple, Microsoft, and - sometimes - Google. As far back as 2018, pundits were discussing whether Apple’s trillion-dollar valuation was symbolic of a market top. What might this mean for 2020?
Elon Musk actually did it. While The Ignorant Investor is not necessarily a big fan of Elon Musk (primarily issues related to corporate governance, follow-through on corporate promises), he is readily willing to admit that the CEO managed to hit some impressive numbers and pull off a short squeeze that surely deserves a golf clap (this might be a good place to reference Keynes sage advice* for a second time in one post). Hey, in terms of sheer number of shares bet against the company relative to company size, Tesla has consistently ranked near the top in recent months. Tesla as a company has been an important pioneer for the electric vehicle world, but Elon Musk IS Tesla, and a bet on Tesla is a bet on Musk himself. This is why The Ignorant Investor bets neither for nor against the company.
From Wall Street to the White House? Bloomberg. Whenever The Ignorant Investor hears that name, he thinks of Bloomberg Terminal, the access point for many investment professionals to the data streams permeating the public equity markets and beyond. But in this case, we’re talking about the man behind the product. The Ignorant Investor is following Mike Bloomberg’s unprecidented approach to the Democratic nomination with a great deal of interest and curiosity. Will flooding all forms of media that Americans consume with pro-Bloomberg messages clinch the man the Democractic presidential nomination? Mike is undoubtedly smart, ruthlessly calculating, and truly rich. He may have entered the race late, but nobody is laughing now that the DNC unexpectedly changed the debate rules just so that Bloomberg can participate.
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* “Markets can stay irrational longer than you can stay solvent” – John Maynard Keynes
