A Tale of Two Markets

One of my favorite authors, F. Scott Fitzgerald, wrote: “The test of a first-rate intelligence is the ability to hold two opposed ideas in mind at the same time and still retain the ability to function.”

And that’s what investors are compelled to do today: hold two opposed ideas at the same time and still function. On the one hand, the bull market confers huge opportunities for making money. And yet, stocks are overvalued and the risks of a correction are mounting. By reading the following Q&A, you’ll find ways to square the circle.

For this week’s Big Interview, I swapped roles. Instead of asking the questions, I’m answering them.

My colleague Jim Pearce is the interviewer. Jim is the chief investment strategist of Personal Finance and you’re probably familiar with his writings. A former stockbroker and financial planner, Jim boasts a superb track record at picking money-making investments. He also asks good questions, so let’s get to them.

Jim Pearce: How do you expect the U.S. economy to perform in 2020?

John Persinos: Although in its late stage, the aging economic expansion is on track to continue in 2020, but at a slowing pace. Industrial activity is contracting in developed and developing countries alike, weighing on growth at home and abroad. But we’re seeing unexpected shoots of growth in crucial economies such as Germany.

The bull market is likely to remain standing as 2020 unfolds, girded by a confident consumer in a mood to spend. Retail sales broke records this past holiday season, a promising portent for at least the early part of 2020.

The chances of a full-blown recession in 2020 have lessened but growth will sputter in coming quarters, in large part because of the trade war. Despite the phase one Sino-American trade deal, roughly two-thirds of U.S. tariffs remain in place.

According to the consensus of analysts, the final numbers will show 2.3% annual growth in U.S. gross domestic product (GDP) in 2019 followed by an anemic 1.8% in 2020.

Fourth-quarter 2019 corporate earnings growth is on track to post a negative performance. What does the full year have in store for earnings?

For starters, let’s acknowledge the fact that the earnings recession continues. As you and I speak, the blended earnings decline for the fourth quarter is -1.9%. Here’s a chart that tells the story.

The fourth quarter is weak so far, but earnings should improve. Consensus estimates call for a year-over-year earnings growth rate of 9.7% for the S&P 500 in calendar year (CY) 2020, which exceeds the 10-year average annual earnings growth rate of 9.1%.

All 11 S&P 500 sectors are projected to report year-over-year growth in earnings. This estimated earnings performance for 2020 exceeds the earnings growth rate of 0.3% for CY 2019.

What sort of stock market gains do you envision for 2020?

The table is set for further gains in stocks in 2020, but at a diminished trajectory. Projections for the direction of the stock market in 2020 are all over the map, but the consensus seems to be muted gains in the area of 8% to 10%. That sounds about right to me.

Defensive sectors (e.g., dividend-paying utilities, consumer staples, and real estate) should continue beating the broader market, as investors rotate from momentum stocks toward value and safe havens.

The tax cuts passed in 2017 no longer drive earnings growth, which means corporations will be more vulnerable to the global synchronized slowdown. Meanwhile, stock valuations remain relatively high. The disconnect between earnings growth and valuations is likely to trigger stock market sell-offs in coming months.

What about bonds?

Because we’re still in an environment of ultra-low interest rates, bond investors will have to settle for modest returns in 2020.

Ten-year Treasury yields remain near record lows, which means there’s scant room for Treasury notes or investment-grade bonds to appreciate in price or to produce appealing levels of interest income.

The bullish case for investment-grade bonds going forward is a full-blown recession, which doesn’t seem to be in the cards for 2020. But that could change.

Will emerging markets finally bounce back and offer growth opportunities?

Developing economies took it on the chin in 2019 but they should bounce back in 2020, due to persistently low crude oil prices and intact economic growth in the U.S. and European Union.

However, the long-running trade war probably won’t end in 2020 and a resumption of tariffs could threaten an emerging market resurgence. The coronavirus could quash a rally in Asian emerging markets, too.

Where do you see energy markets heading in 2020?

Oil prices have been volatile and on a downward slope, weighing on the top and bottom lines of companies in the energy patch. The global coronavirus outbreak is slamming crude oil prices, due to concerns that the deadly illness will dampen travel and economic activity, in turn undercutting demand for fuel.

However, energy demand and per-barrel prices should regain altitude over the long haul because of the rise of middle-classes in emerging markets. This mega-trend makes fundamentally sound but beaten down energy stocks good value plays now.

Over the short term, though, oil prices are likely to remain turbulent and caught in a downdraft. China is the world’s second-largest oil consumer and the country is having difficulty in containing the coronavirus outbreak.

The uncertainty in China is offsetting optimism over OPEC production cuts and recent unexpected reductions in crude oil inventories. Don’t underestimate the risks posed by the coronavirus. A pandemic would give investors the excuse they need to head for the exits.

John Persinos is the editorial director of Investing Daily. You can reach him at: mailbag@investingdaily.com