The New Year Shaping up to be Eventful

By Ketu Desai

The bulls remained in charge of the equity markets. Fed balance sheet expansion, improved economic data, and more clarity on USMCA, Brexit, and the trade war with China drove returns in December. The Fed continued to provide liquidity to the market. The Fed's balance sheet has grown over $300bn since September, and is expected to continue to expand through the first quarter of 2020. The Fed is unlikely to raise rates in 2020, as a very important shift in thinking appears to be occurring within the Fed. Recent comments from the Fed suggest that they are now comfortable with inflation running hot, a significant departure from their policy over the last 40 years. This means that the Fed will continue to support policies to keep the expansion going, and give the economy room to run, even with low unemployment. With the support of the Fed the economic data has improved and we have seen the Atlanta Fed GDPNow go from just 0.30 percent in November to now over 2 percent for the 4th quarter. Low rates have been particularly supportive of the housing market, homebuilder confidence hit the highest level in 20 years, and housing starts and permits hit a 12-year high. Housing has an important multiplier effect across the economy and with Millennials now entering the housing market and in their prime income years, this could be a multiplier that could last for some time.

The economic data has also been better internationally, particularly in China. Chinese industrial production, retail sales, and PMIs have all improved, while the PBOC continues to pump liquidity into the system. Citi's Eurozone economic surprise index is at its most positive level since early 2018. With the improvement internationally, the dollar index sold off below its 200-day moving average. A weaker dollar could further be supportive of risk assets. Emerging markets, European equities, and copper have all benefited from the weaker dollar. Emerging markets trading at just 13.3x and more than 10 percent below their January 2018 high, could be an outperformer in the year ahead. The weaker dollar also benefits S&P earnings growth, as it is estimated that 40-50 percent of sales come from abroad, with an outsized benefit for tech, which gets approximately 60 percent of its earnings from overseas. A 1 percent move down in the dollar, is approximately a 30 bps increase for S&P earnings. A weaker dollar and low/negative real yields also favor gold as an important hedge for the portfolio.

Looking ahead to 2020, global growth is expected to increase from about 3 percent in 2019 to 3.2 percent to 3.4 percent in 2020. Chinese growth is expected to be near 6 percent, and Eurozone growth is expected to be slightly more than 1 percent. Domestically, growth is estimated to be between 1.8 percent and 2.2 percent for 2020. The swing factor for growth could be the elimination of some or all of the tariffs, which could add up to 0.3 percent to GDP. Similarly, for earnings, JPM estimates that the partial resolution to trade helps push S&P earnings up 10 percent to $180 next year, and a full tariff rollback could lift S&P earnings to $184, while escalation could keep earnings at $171. Nearly all of the gains in 2019 were driven by multiple expansion, earnings will likely end up around flat. At the current interest rate and inflation environment, multiples still do have room to expand; however, we will need earnings to grow for meaningful returns in 2020. With the improvement in global economic data, supportive central bank policy, weaker dollar, and some clarity on many of the issues plaguing the market over the last couple of years, there is reason to believe earnings growth will return. It will be another eventful year!

Happy New Year!!


Ketu Desai is the Principal of i-squared Wealth Management Inc. ( ), an investment management firm based in New Jersey.