Market Commentary: January 2020

Market Crosswinds to Start the Year

• January 2020 felt eerily reminiscent to January 2018. Equities, following strong performance in the preceding year, continued their ascent before selling off significantly toward the end of the month. But there are two notable differences leading us to believe we are not in for a repeat of 2018’s turbulence:
• While January 2020 and 2018 perpetuated breakouts from long consolidation periods (21 months and 18 months, respectively), this year’s move followed a larger peak-to-trough consolidation. This is favorable, as more volatile consolidations tend to shake out greater numbers of investors and set up a larger wall of worry (which is good for equities).
• The length and magnitude of the current post-breakout period has been far shorter, again to its favor. As the graph below demonstrates, a shorter breakout likely means there is more room to run.

Source: FactSet

• In terms of valuation, it is worth noting that although the MSCI All Country World Index (ACWI) finished ~7% higher last month than it did in January 2018, the index’s price-to-earnings (PE) ratio finished the month 10% lower than two years ago. Put differently, over the past two years, growth in earnings outpaced growth in equity prices, allowing the market’s valuation multiple to contract, thus alleviating concerns that the market has gotten ahead of itself.
• Economic numbers continued to come in favorably:
• Jobs numbers blew out expectations (225,000 added in January vs. 158,000 expected)
• Wage gains were solid at 3.1% (versus expectations of 3.0%)
• The Institute of Supply Management (ISM) Manufacturing Purchasing Managers Index (PMI) bounced back sharply from December (50.9 versus 47.1)
• January was a tale of two separate periods. The first, through 1/22, was emblematic of the standard January effect we often see wherein optimism from holiday selling as well as rebounds from tax-loss selling the last week of December give way to a January rally. The second period of the month and into early February was all about the Coronavirus. Although the outbreak began in early December, serious concerns about contagion did not surface until mid-January, leading to a harsh equity market pullback. This is especially true in emerging markets, where China—ground zero for the outbreak— accounts for approximately one-third of the index. U.S. markets were not immune, cratering in the aftermath of the Center for Disease Control and Prevention’s 1/22 after-market announcement of the first case to be found on U.S. soil.
• Our portfolios were well positioned given the disproportionate impact of the Coronavirus concerns on markets outside of the U.S. Specifically, domestic equities had their highest excess returns over international developed and emerging markets in 18 months.
• Even more notable, January was the strongest month for U.S. large cap growth over U.S. large cap value in 11 years. For all the clamoring in the financial press about how it may be time for value to reassert itself over growth, the market is saying otherwise, and our models agree.
• The bond market’s reaction to the jobs numbers was somewhat surprising since one would expect yields to rise rather than fall across the board. We do not believe this is as big a concern as some may think; we believe the bond market may now be extrapolating greater prospective impact from the Coronavirus than previously thought. While we are not positioned to project the effect of the virus on the economy, this paradigm suggests the bond market may be set up for an upside surprise (i.e., rates moving higher) if the Coronavirus is contained.
• Since the start of the year, we have heard many pundits talking about how this market is analogous to 1999. Ray Dalio said “cash is trash” based on the current level of interest rates and that a TINA (i.e., There Is No Alternative) market in stocks has reasserted itself. While these sentiments may be directionally correct, we continue to believe any analogies made to the market in the late 1990s are misguided for three reasons: 1) today’s market valuation isn’t anywhere near 1999, 2) companies today are cash-flowing far more than they were back then, and 3) retail participation in today’s market is more subdued. This is not to say there is not mania in this market; the price action of Tesla stock would certainly suggest otherwise (up 128% from the start of the year to its early February high!). However, such phenomena are far more the exception than the rule, a sharp contrast to what the market displayed in 1999.
• The Federal Reserve left the Fed Funds rate unchanged.
• This was in line with what the Fed Funds futures market had been predicting, meaning investors were comfortable with the Fed’s three cuts in 2019.
• The bond market began to price in a greater chance of a rate cut in either March or June. What is unclear is whether this is more a function of the Fed’s outlook from its meeting notes or from concerns about the effect of the Coronavirus on the economy and/or a combination of the two. Regardless, the bond market currently seems more desirous of another cut during the year, and these developments bear watching as the yield curve becomes in focus again.
• From the market’s perspective, political developments were directionally positive.
• The market had strong results the day after the Iowa caucus, as concerns about Bernie Sanders winning the Democratic nomination were somewhat ameliorated by a strong showing by Pete Buttigieg. Additionally, Michael Bloomberg moving to the thick of the primary picture was another soothing development. As referenced multiple times late last year, the market’s price action made it fairly clear that the market never warmed to the idea of a potential Bernie Sanders or Elizabeth Warren presidency.
• As expected, President Trump’s acquittal in the Senate did not have a substantive impact on the market.

What We Are Watching

• There is no Fed meeting in February. The bond market’s reaction to the meeting commentary in January gives credence to our thesis that the committee is likely to take a more dovish tilt with the new committee makeup. The March 17-18 meeting will be key in affirming or rebutting this.
• Emerging markets are likely to continue to take the brunt of any Coronavirus concerns. Prior to last month, emerging markets had begun to show signs of life on an improved economic outlook and a weakening U.S. dollar. We will look to see if the Coronavirus concerns begin to seep into the economic numbers and mark a setback.
• Given impeachment is in the rearview mirror, the Chinese may be more willing to get a Phase 2 trade deal done, especially given concerns about its economy and Coronavirus’ impact. In early February, China made a good faith gesture in reducing some tariffs. We will look for signs of even further thawing in the trade tensions.
• Standard seasonality dictates to “sell in May and go away” (until November). However, in presidential election years, weakness has typically started a little earlier, usually in March or April. Although the S&P 500 has done well to regain its footing in early February, we would not be surprised if seasonal weakness begins even earlier this go-round, in line with historical norms.
• As consumer spending and housing numbers impress, we will continue to monitor them closely, as they are strong harbingers of future economic performance.