Investing for 2020

Economic and market perspectives for a new year and a new decade.

Rolling into a new year is always exciting, it’s full of promise, resolutions and a chance for a clean slate — but rolling into a new decade is even better. The world is on edge as the political cooker boils, science and climate heat up, and markets sit at all time highs. It’s building to an inflection point and you can feel it in the air. The year of the Rat will be a year to remember.

Although 2020 will be a year of catalysts there’s also a general feeling of waiting. Waiting for something to happen. Sure, there’s a potential end to Brexit, Hong Kong might calm down, and the U.S. has one of it’s most divisive elections in history but we seem to be waiting for something to spark the fuse. A natural catastrophe, a political crises, an economic crises or a great fiscal expansion. It’s impossible to say what it is, but there’s definitely a sense of anticipation.

Since the start of 2019 discussions about being late-cycle have shifted to being talk of mid-cycle and the fears of yield curve inversions have almost been forgotten. The deep pessimism has given way to this collective waiting and questioning. Will there be a trade agreement? Will Brexit happen? Will the Fed cut rates? Will the Government engage fiscal policy? Will the economy come crashing down? Will Trump tweet something outrageous?

The answers will probably lay in the wake of 2020 and not in the year itself; but this year of catalysts will be an exciting year and the start of an exciting decade.

REVIEW OF THE 2019 FORECAST

The 2019 forecast turned out to be a great result with accurate outcomes and strong picks. I admit I was too cautious going into the year and it finished with a bigger bang than anticipated but I’m happy with the calls and can still see some of the same underlying risks; anyway, here’s a dot point recap.

1. Volatility remained throughout 2019 until it reached a crescendo in August and has remained relatively flat since.
2. Inflation rose modestly amid pressure from trade and improvement in wage growth from full employment forcing firms to compete for labour.
3. Correctly called the upward move of markets but missed the size of the movement.
4. Positioned for a relatively defensive portfolio using behavioural portfolio theory. Happy with the call and the outcome was solid.
5. Aussie Banks turned out to be duds again in 2019. They haven’t gotten over public and political pressure or the continuing discussion about the new social licence required to operate in the 21st century.

Picks from 2019:

MSFT: $101.12 to $157.41 [+55%] |\| VISA: $132.92 to $188.00 [+41%]
XRO: $41.95 to $80.47 [+92%] |\| BBN: $2.14 to $3.46 [+61%]
KSL: $0.95 to $1.46 [+54%] |\| FDV: $0.47 to $0.82 [+74%]
NEA: $1.50 to $2.66 [+77%]

I have to admit that this is the most successful year I’ve had on individual picks and a big factor was the bull run that became a rising tide to lift all ships. That same bull run made 2019 look like a truly exceptional year for virtually everyone, but we can’t forget that significant drops in Q4 2018 including December’s drop of >8% created a low base to start from.

The 2020 Outlook

The roaring 20’s were a hundred years ago, they were born out of the ashes of World War One, powered on optimism and new technology but ended up plunging into the Great Depression. It was a glorified time in modern history with the ‘Flapper’, and cultural edge fondly remembered. I have a feeling that the twenty-twenties won’t be remembered for the same exuberance but it will be a decade that sets the stage for change and the enormous 2030s.

Looking ahead in dot point:

• Political events will drive the year — rhetoric is the key risk — it’s not hard to imagine political debates escalating and causing disruptions; but it’s a wait-and-see as we all know certain politicians can be unpredictable.
• Private equity to come out of the shadows after huge capital inflows create competition for acquisitions and exit strategy pressures. This will have a major impact on financial markets and investment opportunities.
• A general cycling out of consumer tech and financial stocks into resources and raw materials as trade agreements revert demand to normal and supply chains get going again.
• Energy to be the big opportunity of the year and decade, as the natural world continues to create strain, social angst and questions the viability of ‘traditional’ production and consumption.
• Flat volatility for the first half of 2020 supported by slow upward trending growth as income gets reinvested. The markets will be up at the half way mark (June/July) but that may be the best of times and the year will finish mid single digits up.
• Trade is an issue for the decade not the year. Think about the Japan and U.S. 1990’s trade dispute, Cold War etc. — none are done over night. .

Key Economic Trends

2020 will be a year where several key economic trends of the teens and the oncoming twenties will become apparent. Millennials will finally become the drivers of growth in a multi-year consumption driven expansion and baby boomers will continue to drive up asset prices as their investments and investment income grows and get reinvested. These are two critical elements in understanding our current and future economic position but other factors like monetary policy, debt and productivity need to be considered as well.

Just after the roaring 20’s John Maynard Keynes had the foresight in his General Theory to predict our current monetary situation.

“There is the possibility…that, after the rate of interest has fallen to a certain level, liquidity-preference may become virtually absolute in the sense that almost everyone prefers cash to holding a debt which yields so low a rate of interest. In this event the monetary authority would have lost effective control over the rate of interest. But whilst this limiting case might become practically important in future, I know of no example of it hitherto.”

In modern economics this is called a liquidity trap; and this is where we are right now. Monetary policy has reached a point of ineffectiveness and can’t drive the growth the world’s demanding. It’s largely failed in the modern economy because of a number of factors including the current economic make up. Large wealth inequality means that because intermediaries the stimulus is travelling through the money is directed to wealthier firms and clients that have a low marginal propensity to consume. These people are more likely to reinvest or sit on the cash rather than spend it and therefore the stimulus doesn’t reach the real economy and make the impact it’s meant to. The immediate stimulus of the Great Recession was necessary but the following rate cuts and quantitative easing meant the real economy went untreated while the financial economy got a high dose of antibiotics and steroids. Monetary policy needs to pull levers such as ‘access to credit’ rather than the ‘price of credit’ if it is to stimulate growth in the real economy.

Given the current debt and labour conditions around the world, the only way to deliver the exceptional growth being demanded is through policy reform or fiscal stimulus. This is because at the end of the day the economy is mostly driven by household spending and real people like you and me. Economics and financial markets need to remember the human context if they are to be successful. It’s not all about the numbers, it’s also about the emotions, the feelings, reactions and animal spirits or moral sentiments of everyday people.

One of the key sentiments dragging the economy into the doldrums has been millennial’s worry for the future. This concern isn’t unfounded when you remember that as millennials entered the workforce they found the world in recession; with tough employment conditions, high student debt and general fear. This created a level of uncertainty and worry that meant they pushed back life’s milestones. They stayed for home for longer, put off getting married, having children and buying homes. All this put a drag on consumption and the overall economy. The tail end data of 2019 shows that drag lifting and U.S. consumers carrying the global economy forward.

The relentless march of time has forced this generation to a biological and social point where they have to start engaging in these high consumption and high value activities. We’re only at the start of this trend and we’ll continue to see it pick up pace through 2020 and beyond but it won’t prevent the need for policy reform. More likely this trend will provide reasonable and consistent growth for the year(s) ahead. That being said; consumer preferences are changing and this change is bringing about some great opportunities.

Millennial and Gen Z preferences mean disruption and a long term perspective now go hand-in-hand.These consumer preferences and climate pressure are forcing business to ‘disrupt’ themselves and move to sustainable long-term models. This means sustainable production and also sustainable business practices — ethical business practices. You simply can’t invest in companies with poor governance or dubious sales tactics. The media, political and consumer backlash is too immense. This was reinforced at ‘The Business Roundtable’, where a group of nearly 200 CEO’s of major companies issued a statement with a new definition of the ‘purpose of a corporation’.

Between the changing consumer preferences, major political events, and liquidity trap, some commentators believe the world is in a state of entropy. A place of gradual decline into disorder while the economy lacks the energy to get its feet unstuck from the mud of economic worry. In Australia, Hong Kong, South Africa, South America and much of the Southern Hemisphere or regions/cities central to the operations of the Southern Hemisphere, I have to agree.

Australia is being held up by high immigration but in the wake of the horrible fires, smoke, corruption and an absence of political leadership then I think the end of its economic run is near. The recent Australian trade surplus showed a sign that businesses aren’t restocking and are instead choosing to sell down inventory on the expectation that consumers won’t be spending during the busiest retail time of year (Christmas). The Australian government and their obsession with a surplus that means nothing is like the emperor with no clothes.

The Northern Hemisphere shines bright in 2020 for me. Europe has young and hopeful political leaders, the U.K. has a path forward, U.S. consumers are great, and the emerging markets of India, Nigeria and Vietnam look to continue the march forward. China will continue to develop home talent and gather pace as it’s middle class bulges. If there is a forgotten risk, then it’s that a surge in consumer demand from election outcomes could drive up inflation but most likely that won’t affect 2020, rather it’d be a factor for 2021.

Unfortunately the optimism in the Northern Hemisphere is difficult to capture as the productivity and demographic booms are almost impossible to record. The benefits of cloud computing, SaaS, AI, flexible working, quality improvements and equal rights are tangible in that we can see and feel them driving the world around us but they aren’t captured in the stats.

The effect and demand for these productivity enhancing attributes is there. Businesses are engaging these services, models and belief systems; and when these changes are combined with the changes of consumer preferences, I suspect that this may be the last year of dependable growth before a downturn.

A downturn is inevitable given the current economic imbalances but it should be looked upon favourably as it will really signal a global pivot to new technology and new drivers of economic growth. The political and social catalysts required for the pivot will happen in 2020. Then 2021 will be a tumultuous year as the world pushes forward with creative destruction. You can probably tell now that it doesn’t matter if we are late-cycle or mid-cycle, the ingredients for change are there and all we’re waiting on, is a catalyst.

The labour market or the repo market are likely candidates as catalysts to a wide spread downturn. The labour market has some dark secrets hidden in the numbers. Debt levels appear to be driving young mothers into the workforce, more people are taking on second jobs, competition for low hours and low wages is heating up and yet the labour market is tight. In an almost FOMO phenomena, while more people have gotten jobs, it’s triggered even more people to start looking for jobs. The increased participation rates and high rates of immigration have coupled with the gig economy to create efficient wages …. or underpayment of wages and struggling households. So it’s safe to say there’s a few troubling signs underlying both the U.S. and Australia employment data but it’ll take time for it to come out in the wash.

Economically speaking it looks like we are in for a transitional decade. The year 2020 will be edging closer to an inflection point in 2021/2022 where a period of creative destruction and recession will pave the way forward for sustainable consumption. Despite this coming year being in the economic waiting room, there are lots of engines for growth if governments embrace them. There’s baby boomer capital for investment, millennial family oriented spending, and opportunities across the continents of Africa and Asia with rapidly growing middle class populations.

Financial Markets

Something I’ve loved about 2019 is how efficient the markets have been. The debate about recessions vs growth, the rejection of floats like WeWork or Latitude. The mix of opinions is exciting despite it feeling like a mouse running on a wheel — stuck in motion.

The commentary around upside and downside risks demonstrates how cognisant market participants are of what’s happening in the world. If we are thinking of productivity enhancements then we don’t have to look any further than the financial markets. Think about the amount of information available to analyse, the podcasts, TV programs, terminals and newspapers available to digest, compute and interpret the deluge of facts and figures.

There are three areas of concern I have for financial markets as we look to 2020. The huge number of CEO’s resigning and exiting businesses, scale and complexity of ETF’s, and the operations of private equity.

There’s no dispute that the funds management business has gotten tougher. Fund managers now compete with ETFs, private equity and each other. In fact, the growth of these two competitors is creating some peculiar dynamics within markets that may end up being to the advantage of the fund manager in the mid to long term.

Exchange Traded Funds (ETFs) are a great product that came out of the post 1987 crash’s regulatory recommendations. They provide a relatively simple vehicle for investors to use and track/own an underlying basket of securities. Due to this simplicity and effectiveness they’ve skyrocketed in popularity and are recommended to nearly every investor by nearly every investor; but their hidden complexity is starting to trouble me.

The shares of ETFs can be highly illiquid and have large buy-sell spreads. They may also be holding underlying securities with significant spreads and illiquidity. These risks compound as a new breed of ETFs is coming to market. The ETF made of ETFs. For example you can buy a ‘Balanced’ ETF that owns a mix of other funds. This extra level of complexity furthers liquidity pressures and also creates more distance between the investor and the underlying securities. The ownership gap and illiquidity could exacerbate and accelerate a downturn as the need to sell assets would cause prices to jump spreads, rapidly pushing the price down and the speed/scope of the downward movement would be amplified by the time lags from the layers of complexity.

When it comes to private equity it becomes a story of too much growth. Private equity (PE) seemed to be the only place in the world to get a decent return in a low growth environment. Those guys in PE were making money hand over fist as they bought companies listed or private, spun them around and sold them back to the market. Naturally the capital started to flow in. Typically reserved the wealthy and the fund managers, private equity opened its doors to everyday people and then the capital poured in.

The number of assets listed on global exchanges has since plummeted. Fund managers have moved to private equity and the competition has gotten tougher. While finding new assets and companies has gotten more difficult the private equity folks have climbed up the risk curve. But a key part of private equity is having an exit strategy. You have to be able to sell the business later, and that’s usually through an IPO — listing it on the stock exchange.

There’s so many companies looking to be sold by the PE industry that fund managers have been afforded the luxury of being selective. Market commentators and the availability of information has meant that these companies can be investigated thoroughly and if found to be a rotten egg, turned down. This was most obvious in the now famous WeWork float, but what isn’t obvious is that this is becoming a concern for the whole private equity sector. A narrowing of exit strategies and opportunities constrains their businesses and they may be left standing empty handed when the music stops.

You might think that all this corporate activity is creating a boom for aspiring and current CEOs. That they can flex their leadership skills and turn a company around or they can ensure that their firm performs so well that they never become a target. Strangely 2019 saw an exodus of CEOs and no-one is quite sure why.

I don’t know why the resignation floodgates have opened in the C-Suite but they are making their impact. There is a sense of a ‘changing of the guard’ as old school operators make way for leaders in tune with the new social contract — or maybe it’s signalling a downturn. A long bull run coming to an end and it’s now time to get out with the options, shares, bonuses and reputation in tact?

Picks For The Year

It’s hard to make calls for upward movement when markets are already looking so hot and valuations so high but the stock picks for 2020 are focused around a few key themes to support the move. The phase one and two trade negotiations between China and the U.S., climate change, shifting consumer preferences and risk management.

The trade agreement impacts the entire supply chain including inputs like raw materials, resources and primary industries. With the phase one deal going through I expect that there will be some return to normal supply and demand which will help bring growth back to these businesses.

The impact of high intensity climactic events are felt across the globe and is therefore one of my key considerations for stock picks. For agricultural stocks, trade and climate impact have been combined with swine fever (the aporkalypse) to provide a real shock to the industry, and with shocks come opportunities.

Also being effected by some of the same elements are energy stocks, which are often interlinked with resources or primary production as they require significant land and resource endowments. Energy stocks are particularly exposed to long term opportunities in production technology and both short term and long term changes in consumer preferences.

Underpinning all of these transient factors is the need for strong risk management and ethical leadership/governance to meet the modern social licence requirements. Companies failing to meet ethical standards are being trialled by fire in the court of public opinion and I’m not prepared to take on that risk. The new social licence also requires business to orientate themselves towards a vision of the future. Companies need to be aware of how the landscape is changing and what technological opportunities are in front of them in order to be successful.

As with 2019 I continue with a risk adjusted portfolio using Behavioural Portfolio Theory but here are some picks that you might consider for the coming year.

• Rio Tinto: Energy and raw materials focused it should be supported by trade tailwinds and growing middle classes. Future looking with significant investment in Hydrogen and partnership with CSIRO.
• Inghams/Tysons: Leveraging the high feed costs, drought, swine fever and demand for low cost meat. Rising inputs will have a greater impact on beef, lamb and pork which will mean chicken will experience strong relative demand.
• Microsoft: A great business with good leadership and continuing to win key contracts while building a scalable and profitable subscription driven business.
• Xero: Recent partnerships with financial institutions to facilitate credit approvals will mean more clients will seek to use the product and consequently more accounts will use it. Network effects starting to come into play for Xero and it continues international expansion.
• Berkshire Hathaway: A tried and true company that has solid businesses and cash to deploy, in the event of a downturn it’ll be a true winner but it will also benefit from millennial spending. Biggest risks are Buffet and Munger’s age.
• Mastercard: Exploring new ways to partner with and facilitate Buy Now, Pay Later rather than compete. Possibly swap out of VISA and into Mastercard for a reliable business with a clever growth path.
• Accenture: Draws on key themes of risk management, technology and need for businesses to change. Good leadership and not afraid to make tough decisions it’s set to benefit from the increased demand for its services. Cyber security will also assist Accenture.

Small Cap considerations would be Kina Securities Limited, Dubber and Whispr. These business either use key technology advantages or geographic moats but are riskier and probably investments for the longer term. Overall this arrangement of stocks may seem a little odd but it’s a mix of differing opportunities supported by strong themes.

If you’re thinking of out of the box opportunities then the new S&P ASX All Tech Index may provide just that. The new index will track ASX listed technology stocks and is set to launch in early 2020. It’s launch will no doubt be followed by a smattering of ETF’s designed to track the index and will create demand for the underlying securities. Snapping up some of the underlying securities early and riding the demand wave forward may turn out to be a fruitful short term play. It’s not without risk though — they are tech stocks after all.

Conclusion

It looks like we are headed for a steady 2020 and a great start to the new decade. There’ll be some nail biting, infuriating and exciting moments on the international stage, and we’ll all be waiting nervously to see the results of the U.S. elections late in the year. I believe the year ahead will be a year of catalysts before the downturn into creative destruction and a technological boom.

I hope you and your investments have a fantastic year.

If you have any questions then please feel free to comment, and if there is anything you’d like to see analysis on or read about in the future then let me know.

Also, please note that this article does not represent financial advice or the views of any organization; it is only the opinion and analysis of the writer.

Thank you for reading.

Yours,
Chris Leeson