Many investors entered 2020 thinking they can sit back and enjoy low-risk returns. The thought is understandable but wrong.
A major cause for optimism is that the Federal Reserve and other central banks made clear they won’t tighten the money supply for a long time. The central bankers are willing to err on the side of allowing sustained inflation instead of strangling growth to restrain inflation.
The Fed plans to keep short-term interest rates low while allowing longer-term rates to rise. That is supposed to encourage investors to seek higher returns from higher-risk investments. If the economy stumbles, the central bankers will step in to boost growth.
Other headwinds for the economy and markets over the last few years also seem to be lessening.
The United States and China agreed to a “phase-one deal” concerning their trade disagreements that amounts to a truce in their recent rhetoric and retaliatory measures. Leaders of both countries agreed to additional talks to reach a broader, longer-term agreement.
In the United Kingdom, the uncertainty over the timing and details of its separation from the European Union is ending after Boris Johnson’s major election victory.
The U.S. economy and markets, as well as many of their global counterparts, are responding positively to these changes.
Yet, there are other headwinds to be concerned about and market changes to expect in 2020.
The U.S. market indexes have led world markets in recent years, and a few large growth companies, especially technology companies, have been driving the indexes.
Very high profit margins are a major support of those rising stock prices, but there are obstacles to continued high profit margins.
Extremely low unemployment finally caused average earnings to increase above the tepid rate experienced for most of the economic recovery.
Though raises aren’t likely to reach the levels we typically see in a growing economy, wage increases are likely to continue at 2019’s rates. They put a crimp in profit margins because most businesses still can’t pass higher costs to consumers through price increases.
Growth companies, especially the tech giants, face growing backlashes from governments and consumers. Increased regulations and taxes are additional threats to profit margins. Weak productivity gains and increased international competition also should keep a lid on margins.
The stock market domination of large U.S. growth companies also could be coming to an end. In late 2019, we saw signs that smaller companies and value stocks might be turning the corner. This could be the beginning of a new cycle when value stocks and smaller companies lead the markets.
I also anticipate that the excess performance of the U.S. indexes will erode. U.S. stock indexes returned far more than international indexes since the beginning of 2013.
International stocks sell at much more attractive values than U.S. stocks. Also, many economies appear to have hit bottom after struggling the last few years. Rising growth and low valuations usually are a good combination for investors.
Income investors must be more cautious in 2020. Rising long-term interest rates cause most traditional income investments to decline. As I said, central bankers plan to hold short-term rates down while letting longer-term rates rise.
We saw the negative effects of that policy on long-term government bonds in 2019.
The iShares 20+ Year Treasury Bond ETF (TLT) soared by more than 20% in the first eight months of the year. It declined more than 7% the rest of the year. That recent trend is likely to continue if the Fed is successful.
Investors were surprised by many turns and changes in 2019. Expect to be surprised again in 2020. Your best strategy is a diversified, balanced portfolio and insistence on a margin of safety in each investment.