2019 Markets Review
2019 summary & 2020 predictions
2019 was a vindication year for the traditional asset management industry and asset allocators like us. Many skeptics sat on the sidelines in cash and missed the best year for returns we have had in a very long time. Our clients enjoyed excellent returns in both absolute and relative basis.
While 2017 was low positive and 2018 was negative, 2019 was very positive and brought the three-year returns comfortably into the annual targeted return range. This is the nature of the beast - market returns simply do not go in straight lines.
Our eyes now turn to 2020. As always, the crystal ball has its limitations and across our team we have slightly differing views for 2020. However, the consensus view is to remain faithful to our asset allocation principles.
Understanding 2019 returns
With global equity market gains above 20% and global bond market gains above 6%, 2019 was an exceptionally good year. Realistically, we do not expect these types of returns to repeat themselves in 2020. The numbers are a little misleading on a year to date basis since approximately half of those numbers represent a recovery from 2018. Within the first quarter of 2019, the market had recovered the last quarter of 2018’s losses. The question on the table then was if we should sell and de-risk for the remainder of the year. We did not, and therefore continued to enjoy the positive market momentum. Investors should take lessons from the volatility of 2018. We never really see these things coming but if invested, one has to remain focused on long-term-goals and if not invested one needs to take the opportunities presented.
Whilst many assign the market optimism to fewer controversial twitter comments by President Trump, we believe the real story here is interest rates. In 2018, the Federal Reserve was signaling continued interest rate increases for 2019. This, coupled with Trump’s renewed aggressive stance on China, sent the market into panic (interest rates up means valuations down). In December 2018, the Fed did an about turn and not only stopped increasing rates but started to signal decreasing rates (rates down means valuations up). This, in our opinion, was the major driver. It needs to be said that we are concerned that the Federal Reserve is being too influenced by the market. The Federal Reserve has one main goal – to control the level of inflation – irrespective of market sentiment.
Around June the talk of recession began. Long-term interest rates were lower than short-term interest rates, which is unnatural, and the Fed began to aggressively decrease short term rates, pushing recession expectations further away. This, coupled with toned down China Trade war comments, brought further optimism.
“Hindsight” for 2020
Reasons for Optimism
- 2020 is a USA election year so we expect Trump’s China brinkmanship to be tempered. We even expect a sustained truce or temporary deal. It is well known that Trump’s barometer for support is the level of the S&P stock market, so leading into elections in November we may see positive tail winds.
- The UK uncertainty has finally reached some closure with a strong conservative majority. At the time of writing, Brexit has gone from a 20% probability to a 90% probability. There are thousands of points of detail to be sorted out - any one of which will be used by the media to make Boris look the fool. However, I think, to my surprise, we have gone beyond the point of no return now and Brexit will happen. Ironically, after 3.5 years of disarray, it feels like it will create some positive momentum for the UK market and for the pound.
- The side lesson for me, with respect to the UK vote, is that there is no place in western society for hard-left politics. If we draw parallels to the USA, unless the Democrats come up with a strong center-left leader then Trump will most likely be re-elected. The impeachment process is a sideshow and is unlikely to get through the Republican controlled House. I seriously doubt it will go the full distance and may publicly back-fire on the divided Democrats. It seems that the only thing the Democrats agree on is to be anti-Trump, and this will not win in November 2020. Of the Democratic candidates, Elizabeth Warren and Bernie Sanders are too far left for the average American and while Michael Bloomberg is a strong center-left leader, it’s doubtful if he will win enough support in the primaries. What worked in New York may not work for the rest of America. There are a few lesser-known candidates who may emerge, but no one seems to have the experience for the job. So the default position is Trump is re-elected, which we believe will not be negative for markets. It may even be positive or at least neutral.
- On the more economical-technical side, the Fed reacted quickly and reduced the short-term rates quite aggressively, which seems to have pushed recession fears back. There is still too much debt in the USA and too little inflation, so we expect rates to remain low. We do not expect the USA to become like Europe with negative rates. Low rates mean that the appetite for riskier assets will remain higher and this is positive for investors in general.
- Another reason for optimism, in our minds, is that the research is showing there is an enormous amount of cash sitting on the sidelines. High Net Worth individuals, companies and pension funds have too much cash and if the market of risky assets sells off, then we expect this cash to be deployed, which will provide some sort of downside cushion for the market.
Reasons for Caution
- The post 2008 fundamental economic problems of the world have not been solved. The growth of debt at both a government and corporate level is indeed concerning. Negative interest rates and rate manipulation for monetary policy objectives seems to be like putting a plaster on a wound and doesn’t seem to be healing the wound at all. It is reasonable to fear a day of reckoning on world debt, even if it is many years into the future.
- Trump brought the China-USA relations to the social media surface, but this is a 40 plus year issue that other USA presidents have also battled with. China simply does not respect USA intellectual property rights and they are unlikely to. This is the core of the issue, not tariffs in my opinion, and this will not be resolved to the Americans’ satisfaction anytime soon. The economics of China is such that they are still able to manufacture more cheaply. However, quality is improving and costs — particularly labor costs — are increasing, so their competitive edge is diminishing. China will one day have to deal with a serious inflation problem, the same as the western world dealt with it in the 1970s.
- We remain pessimistic on mainland Europe and are concerned with what the political landscape will bring. Moreover, the world of negative interest rates is a concerning policy mistake, in our opinion, and will be difficult to come out of. For this reason, we have reduced, almost totally, European mainland equity exposure.
- Our main area of concern is on the supply side of the bond market. If the Federal Reserve of the USA Treasury starts to sell more and more bonds, either to reduce the size of the Fed balance sheet or to raise money, the market will not accept this increased supply at any rate and rates will go up. If this happens, then there is a potential to see a full reversal of 2019 bond market gains. It is not clear how the equity market will react in that scenario, but the base case is it would be negative.
What is the worst that can happen?
I was recently asked by a client via WhatsApp “what’s the possible downside of the portfolio”? In our client onboarding process, we have a series of questions and model explanations and part of that is a “maximum drawdown number”. It is natural that after a few years one can forget that number, so it is worth revisiting it with your Personal Wealth Manager, and it’s also worth understanding how we calculate and get comfortable with this number. In addition, it is important to understand the limitations and what sort of scenarios are excluded from this assumption. Without going into detailed statistical theory, one needs to make an assumption on what’s “normal” and what’s “not normal”. In our tests we use historical data — typically 20 years' worth — which means it includes the dot.com bubble of 2000, the subprime crises of 2008, the European crises of 2011 and the recent 2018 China-USA trade war crisis. These are “normal”, believe it or not. What’s not included is, for example, a nuclear bomb on Wall Street or something similar which cannot possibly be modeled.
Our whole investment process is based on strategic asset allocation modeling, where we try to estimate the risk and return of a particular asset allocation. Our modeling process takes the portfolio using indexes, which closely resemble our risk, to see what would have happened. It also uses some statistical models to look at other scenarios beyond those listed above.
The bottom line is we have a statistically significant level of confidence that the maximum drawdowns are reasonable. Whilst no one wants to see a negative year in their portfolio, we must appreciate that they do happen (like 2018) and we do not anticipate any sort of systemic crises in the short-term, which would result in these types of drawdowns.
Long term perspective
Have a look at the value creation and some value destruction of large name companies over the last 10 years.
As you will see, investing in a major name is no guarantee of long term growth and therefore a board market exposure through an asset allocation approach is much preferred.
Largest 20 companies 10 years ago vs. today (Koyfin Research)
The 20 largest companies today and where were they 10 years ago (Koyfin Research)
Israel at a glance
Despite a political stalemate, the Israeli market followed global markets with positive performance. The main equity index, TA125, was a positive 21.27% and the main bond indexes were 7.69% for corporates (TEL BOND MA'AGAR) and 9.11% for government bonds. This too lifted client performance to within their three year targeted numbers. Again, this was an interest rate story rather than a political one.
Short-term shekel interest rates remained flat. However, long-term interest rates came down from 0.25% to 0.1%. This gave investors capital gains on the bonds. Within the stock market index performance, the Israel giant Teva was the biggest negative contributor with an annual performance of about -41% and the once iconic company remains under pressure. The main positive performance contribution came from the listed property companies.
The shekel itself remains strong despite growing debt burden and the continued political uncertainty. The global consensus outlook seems to be for a weaker dollar in 2020, which means we may see the shekel strengthen further towards 3.4. However, we believe there is a limit to what the Israeli economy can withstand and this may bring the exchange rate back to the 3.50 area. A more elaborate review on the Israeli market can be found on our 2019 Hebrew review.
* All the data in the is updated according to 31.12.19 unless detailed otherwise
The aforementioned information is not a substitute for personal Investment marketing, which takes into account the particular circumstances and special needs of each person. The views expressed in this Review should be considered as market comment for the short term for information purposes only. As such the views herein may be subject to frequent change, are indicative only and no reliance should be placed thereon. This Review does not constitute legal, tax or accounting advice, or any investment recommendation, or any offer to buy or sell financial instruments of any kind, and does not take into account the investment objectives or needs of specific investors. Although this Review has been produced with all reasonable care, based on sources believed to be reliable, reflecting opinions at the time of its writing and subject to change at any time without prior notice, neither Pioneer Wealth Management nor any other entity or segment within the Pioneer International Group makes any representations or warranties as to the accuracy or completeness hereof and accepts no liability for any loss or damage which may arise from its use. The writer and the company are unaware of any conflict of interest at the time of publishing the above commentary.