by Brad M. Weafer, CFA, Chief Investment Officer
2019 was a strong year for equity returns, but it is now in the rear view mirror. Positive returns have continued year to date and we thought it was an opportune time to let clients know about key developments we are paying attention to today.
1) An End to the Trade War with China
The Trade dispute between the world’s two largest economies has been brewing for nearly a year and a half. A framework for a preliminary deal was recently announced, but many details have yet to be worked out. The deal promises to postpone indefinitely the scheduled U.S. tariff of 15% on $160 billion worth of Chinese imports and reduces the existing 15% tariff on $120 billion worth of goods to 7.5%. In turn, the Chinese agreed to increase imports of U.S. goods, including farm products, and increase protection of American intellectual property. The U.S. Tax Foundation estimates tariffs imposed so far by the administration reduce long-run GDP by 0.26%, and if the now rolled back tariffs were enacted, GDP would have further reduced by 0.24%¹. For an economy growing an approximate 2% the impacts are more material. We expect news on this front to continue to drive investor sentiment.
2) CEO Confidence
Recent survey results suggest corporate CEO and CFO confidence has been declining at an accelerated pace. Businesses and economies need investment to grow. If management teams are not optimistic about the future, they tend to invest less. Not surprisingly, several studies suggest a strong correlation between GDP growth and CEO confidence (see Figure 1 below). Given the recently announced Phase I trade deal, there is reason to think the recent trend may turn.
3) Earnings Estimates
Companies are in the midst of reporting fourth quarter’s numbers, but based on current estimates, earnings for the full year S&P 500 companies are only expected to grow 1.1% in 2019. Estimates for growth in 2020 call for a sharp acceleration in growth, 9% for the full year (see Figure 2 below). Meeting these lofty assumptions requires a rebound in global growth. How companies fair against these expectations will be a key driver for stocks this year.
4) Investment Implications of the Election
Politics tend to draw a significant amount of attention from our clients. The attention early this year is focused on the Democratic primary race. As the chart below shows, the “favored” candidate has shifted over time. We have also seen different companies/industries react to changing trends in these odds. Nowhere has this been more acute than the healthcare industry, where a progressive agenda could threaten certain business models and pricing. The attention and volatility caused by concern over political shifts is likely to only increase as we get closer to November. We have no advantage in forecasting elections, but pay close attention to how potential changes affect our companies and look to manage risk accordingly. This will be a key focus for us as the race evolves.
So What?
As of this writing, the S&P 500 is just below all-time high. The market has largely shrugged off disconcerting events (the Coronavirus, Iranian conflicts, etc.) and both investor sentiment data and valuation levels point to some complacency. Looking ahead, equity returns follow profits of the underlying businesses. Estimates for profit growth would support high single digit returns should the economy continue to grow at current pace. There remain a number of signs that indicate the U.S. is in the latter stages of the cycle, and late cycle economic growth is more vulnerable to negative surprises, political or otherwise. We have a more favorable view on the outlooks for the companies we own, but they are not fully immune to economic risk. Over the last year we have been proactively taking steps to reduce areas of cyclical exposure in portfolios. We have also invested in companies that have independent avenues of growth, including property and casualty insurance and vehicle auctions. Another method to manage risk is shifting the mix invested between riskier assets (like stocks) and safer assets (like bonds). Following the strong performance of equities, we advocate clients be mindful of their exposure and re-balance portfolios to long-term strategic targets to help manage the potential risk to balanced portfolios.
¹ https://taxfoundation.org/tariffs-trump-trade-war/
Financial Pages Disclaimer: This publication is for informational purposes only and should not be considered investment advice or a recommendation of any particular security, strategy or investment product. The information contained herein is the opinion of Boston Financial Management and is subject to change at any time based upon unforeseen events or market conditions.