At the beginning of 2019, we highlighted three key areas that would have the most profound impact:
- Has Globalization Peaked?
- Connectivity to the Max!
- Demographics: The Domino Effect
These themes played out quite nicely in 2019. Our Canadian equity was up over 30%, our International holdings were up over 20% and our exposure to the Emerging markets returned almost 15% – an equity-only return of 22.0% vs our standard benchmark 17.2%. Since SANDSTONE client portfolios are not 100% equity, individual returns will depend on your personal allocations to stocks, bonds, and cash.
2019 was “supposed” to be a year of quantitative tightening. The Federal Reserve (the Fed) announced plans to keep its balance sheet reductions on autopilot while hiking interest rates three times. Instead, we saw a full reversal of Fed policy; an increase to its balance sheet and three interest rates cuts, which led to a surge in the market.
GLOBAL MARKETS ARE BECOMING PROGRESSIVELY MORE ARTIFICIAL THANKS TO CHEAP MONEY AND PASSIVE FUNDS
These global transitions have led to a significant disconnect between the stock market and the economy. Currently, the stock market has a mere 2% correlation with the economy – this has never happened before.
“At any given moment, the equity market is influenced by an array of factors, such as liquidity, valuation, sentiment, market positioning and momentum. Normally, what the economy is doing explains at least 50% of the moves we see in equities and is never less than 30%.”
David Rosenburg
In 2019, we experienced a profits recession coupled with double-digit stock market returns. This has only ever happened twice before, both times emerging from a recession (2001 & 2008).
Further, triggered by “tweets” and news headlines, global equity markets are being increasingly driven by algorithmic trading. Never has this been so apparent than with the U.S./China trade conflict. Think of all the times this commentary has dominated headlines while influencing the market daily. Trade deal ‘on’ pushes markets higher; trade deal ‘off’ sends markets lower – rinse and repeat.
DISCIPLINE AND THE MANAGEMENT OF RISK WILL BE ESSENTIAL FOR CAPITAL PRESERVATION
SANDSTONE portfolios have seen a gradual increase in weighting towards market alternatives. The allure of market alternatives is the low correlation to the influences of mass media or Twitter.
Still, heading into this new decade there are many questions yet to be answered:
- Will central banks continue to control the narrative in 2020?
- In 2020 will we see the first-ever four-quarter profit recession while continuing the historic 10-year bull run?
- Is this the year the US/China trade spat comes to an end?
- Has the $US topped and are we seeing a shift in global capital flows?
- Could we be headed for a new commodity cycle?
- Are the risks of inflation underappreciated?
- Are market alternatives the new way to balance risk?
We believe that the markets are ripe for a pullback. Given the strong performance in 2019, profit-taking would not be unusual and a reversion to the mean would be healthy. Now is not the time to chase. Discipline and the management of risk will be essential for capital preservation.
Something to think about from Ian Bremmer’s Eurasia Group:
On August 16, 1953, Dwight Eisenhower walked into Washington's Statler Hotel to give his first formal speech as president to the American Society of Newspaper Editors. He used that address, which he titled "Chance for Peace", to make the case to both Soviet leaders and the American people that a US-Soviet Cold War was a bad idea – and not inevitable.
In it, he detailed how many schools, hospitals, and power plants could be built for the cost of a single bomber plane. He warned that "every gun that is made, every warship launched, every rocket fired" represented a "theft from those who hunger and are not fed, those who are cold and are not clothed," and warned that a life spent arming for potential conflict was "not a way of life at all, in any true sense... it is humanity hanging from a cross of iron."
It's worth remembering Eisenhower's warning as we close one decade and open another…
A US-China rivalry is inevitable, but a conflict is not. Constructive competition would spare other governments the need to choose sides in ways that stunt the growth of their countries too.
Where will the current and future US and Chinese leaderships steer this most important of all international relationships? This is the biggest question now facing the United States, China, and the world as we open a new decade.