It is again that time where we should assess what happened last year, review our investments, and prepare for a new year.
As of December 13, 2019, the U.S. S&P 500 market index stands at 3,168 and increased +27.6%, including dividends. The S&P 500 index ended at -4.4% in 2018, so it was an easy target to beat, but even considering that 2019 had a strong performance.
Every dominant U.S. investment asset class (equities, bonds, and private equities) look expensive, but they are not in bubble territory yet. So further increases might be possible.
It is not by chance; this is the case for U.S. assets. The U.S. healthy corporate sector fueled by cheap debt, lower tax rates, and constant innovation has kept a U.S. consumer healthy. The U.S. corporate sector has also held the demand for equities high by doing consistent equity buybacks programs, even when demand for equity funds has waned. Last but not least, the Federal Reserve has started a generous interest rates cuts and money printing buying short term government notes.
International equities valuations are lower than the U.S, but there are valid reasons for these low estimates; these economies (developed and emerging) are not in their best shape. The advanced and emerging economies were already slowing down before the political and international trade issues arose.
The European countries and Japan are already using extreme measures such as negative interest rates to reignite their economies, causing what we might describe as a bubble in their government and corporate bonds. And just recently, Japan initiated a new fiscal plan to support further growth; I think we will see more of these types of initiatives globally.
The trade tariffs have had its most significant impact on the Asian economies, most of them highly exposed due to their export development model, among them Japan, China, and Korea. There is no surprise for anyone that China is eager to reach a reprieve of these trade issues with the U.S.; therefore, they are more willing to negotiate a deal. Although China has already implemented a broad set of monetary and fiscal measures to sustain its economic growth rate internally, in case it fails to defuse the impasse with the U.S.
All over asset prices have reached new highs daily, the key levers just mentioned above may help maintain current valuations or even extend them. Now the key questions, how long will support them? What risks should be considered? Where are the opportunities?
To try to frame these questions, we should first review how the balance between expectations vs. reality might play out in 2020; market psychology is a very relevant aspect for 2020.
During the last quarter of 2018, we faced a completely different scenario than today; then, investors watched worriedly how financial analysts drastically reduced 2019 full-year earnings estimates. The year 2019 came and U.S. corporate and the U.S. economy results were better than feared, not spectacular but good enough. So reality beat expectations during 2019 and fuel hope on investors’ minds; therefore, we reach higher asset prices.
Nowadays, the scenario is quite different; most financial analysts forecast a significant recovery of companies' earnings growth for 2020 and benevolent U.S. economic results and internationally. These 2020 full-year earnings estimates have not been trimmed that much during this last quarter of 2019, and the risk we might face is that they may overestimate growth. So expected reality, although positive, might or might not exceed expectations.
The higher valuation of assets does not mean they could not deliver positive returns, but just that historically expected returns might be lower than average until financial results justified otherwise. Therefore, it is not wise to avoid highly valued assets but to reevaluate the exposure accordingly to your long term investment plans and risk tolerance.
As we have reviewed, there are several substantial efforts globally to support growth ongoing and we must acknowledge these facts to allocated consistently with a value mentality. These are a few of the actions an investor might need to take:
Reassess the overall risk exposure of the portfolio based on your individual cash flow needs during 2020
Place focus on assets with more certain expected returns based on valuations and trimmed those with exceeding gain
Be more granular and look for overlook opportunities by others
Use active management in your mix of passive investment that may generate profit based on volatility and unique opportunities
Maximized contributions of retirement funds and strategies to maximized your tax deferments before year-end
Next year we should also consider there will be a U.S. presidential election, so we should expect in general a media storm of news and opinions, remember 2016. The media's psychological pressure might affect investor’s peace of mind and markets alike, so Keep Calm and Invest Money Wisely.
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I wish you a happy new year 2020 in advance!