"Show Me The Money!"
Here at GreenPort, we love a good romantic comedy, and we are not embarrassed to admit it. What’s so wrong with enjoying a lighthearted comedy that ends with two people falling in love and living happily ever after? Rom-Com’s are often ridiculed by critics, and popular society in general, as shallow and simplistic. Not worthy of being acknowledged as great cinema. Why then does Hollywood continue producing Rom-Com’s? They make money! Jerry Maguire is consistently acknowledged as one of the top Rom-Com’s of all time, pairing the established Tom Cruise with a relatively unknown Renee Zellweger. In his breakout role, Cuba Gooding Jr. plays the talented but difficult to deal with football star, Rod Tidwell. Rod is frustrated that his agent Jerry Maguire, despite Jerry's self-proclamation of being a great sports agent, hasn’t secured Rod a lucrative new contract. Jerry is once again explaining to Rod why it’s not his fault that he hasn’t accomplished what he was hired to do. Rod has heard enough excuses and starts screaming at Jerry; “show me the money!” We understand Rod’s frustration. He wants results, not excuses. At a minimum, Rod wants Jerry to admit his approach isn’t working and to consider another approach. Many of us in the investment industry would be wise to heed this advice. There is a difference between being disciplined and being dogmatic. While we pride ourselves on having a disciplined investment process, we understand that we can’t be dogmatic. When markets aren’t behaving as we expect, we need to be open to the possibility that our thinking is wrong. Sometimes this leads to an adjustment in our investment frameworks. Throughout this current bull market, which is up around 300% over the last 11 years, several prominent market Bears have been calling for a stock market crash. Our issue isn’t that their forecast has been incorrect, we readily admit forecasting markets is difficult. Our issue is their insistence that their thinking is correct, and the Bull’s thinking is foolish. The self-assuredness of the Bears has kept many investors from participating in this Bull market. Even when markets do eventually correct, the damage of not having equity exposure during this Bull market will easily outweigh any benefit of avoiding a pullback in stocks. In between watching romantic comedies over the New Year, we also spent time reading the 2020 forecasts of other market prognosticators. Forecasting one-year ahead numbers is somewhat of a silly exercise. So much changes during the course of a year. Nevertheless, there is usefulness in looking at the current snapshot of the big picture. The most common excuse the Bears gave for last year’s stock market rally is that the World’s Central Banks created ultra-easy monetary which led to a “sugar high” for stocks. Our response is; “yup”. Are Bears suggesting the proper thing to do would be for investors to return the money they made in 2019? The Bears accuse the major Central Banks of carelessly providing liquidity and pushing up stock prices. Once again, our response is “yup”. We’d also respond that our job is to forecast markets, not to cast judgment on the morals of monetary policy. Our investors want us to show them the money. Although we have been vocal about over-active Fed Policy, our only concern is how a policy will impact markets. When the Fed reversed its tightening policy at the end of 2018, we got misty and told them, “you had me from hello”. The stock market whispered to the Fed, “you complete me”. While we are not sure what Rom-Com will best describe 2020, we don't see a recession in 2020. There is no shortage of unforecastable external shocks that can shake the economy and create a recession, but when we view the economy in a vacuum it is extremely unlikely we would see a recession.
A recession is defined as two consecutive quarters of negative real GDP growth. Consensus GDP forecasts for 2020 are solidly positive. The more important question is whether real GDP growth slows in 2020, not whether we technically have a recession. We are hard-pressed to find the reason for a slowdown in growth. Of course, the Fed could disrupt things with an unexpected tightening (lest we forget Q4 2018), uncertainty (or perhaps too much certainty) about the presidential election could create angst, and there is never a shortage of geopolitical events that could disrupt the economy. However, if we look past all the cable news headlines, we continue to see corporate profits rising, led by revenues, which are being led by a healthy U.S. consumer.
Despite the lack of recognition in the financial headlines, productivity has been making an impressive comeback. This continues to fuel margins and keep wage inflation at a rate that inspires workers to work and employers to employ. The primary argument from the Bears (now that they seem to be conceding the recession they promised isn't happening after all), continues to be that valuation is too high. At 18.5X earnings, we'd argue it might be too low. So long as inflation and interest rates remain low, despite current valuation multiples being slightly higher than long-term averages, multiples are justified since the present value of those earnings is also higher. So, the next thing we should check on is that inflation, and therefore interest rates, will not move materially higher. Much like we are still waiting for the recession that we were promised, countless experts have been warning about the return of inflation. Ironically, even with the Fed doing everything possible to create inflation, they are unable to consistently achieve their 2% inflation goal.
The Fed continues to rely on Keynesian models and the Phillips Curve that simply haven't worked for a long time. Central Banks continue to explain they are not wrong, they just haven't gone far enough. Undoubtedly, QE4 will be the answer! There are two reasons why low interest rates are fueling the stock market. The first we already mentioned, a lower discount rate allows for a higher valuation, The second is more subtle. Investors need a return above the current rate that bonds are offering. Therefore, investors buy stocks because of TINA (there is no alternative). It is true that interest rates are below where they should be for our current level of inflation. On average, 10-year yields trade at a level of 2.5% above inflation. While domestic QE certainly had a lot to do with bringing 10-year yields lower, QE by the ECB and BOJ are the reason our yields remain low, and we expect will continue to. A 2% yield on a 10-year bond may not seem very attractive but it's better than earning a negative rate of return, so globally investors are flocking to U.S. Treasuries.
We expect long term rates to remain range-bound in 2020, somewhere between 1.5% and 2%. We will be looking to add duration when we approach 2% and decrease duration as we approach 1.5%. Importantly, if rates do start to trend materially higher than 2%, we will need to consider pulling back on stocks. Buy Local – We have been promoting a buy local strategy for quite some time now. We believe in supporting our local business, especially GreenPort. During a moment of weakness in 2019, we pulled back on our buy local strategy and went from underweight to neutral on European equities. We quickly regretted the decision and returned to our domestic overweight. It's so tempting when valuation is cheaper overseas and the U.S. continues to outperform, to rotate into international stocks.
The problem is and continues to be, that this is a value trap. The reason the U.S. continues to outperform, and justify their higher valuation, is that it is a much better economy. We continue to believe that there are structural reasons for this and that the outperformance doesn't necessarily need to mean revert anytime soon. Deregulation and less bureaucracy, unilateral trade deals, and more a favorable tax policy relative to the rest of the world, means the U.S. economy is producing more profit and growing faster than other developed nations.
A point that is seldom mentioned but is very important is demographics. The U.S. working-age population is increasing while Europe and Asia are decreasing. The evidence is unambiguous that aging populations spend less which hurts economic growth, while also draining the economy through the use of government resources at a far higher rate. We are are not suggesting the twisted economic utopian idea of a "permanent vacation" at a certain age, primarily because of our own age, but old people definitely hurt economic growth.
We've said it before and we will say it again (as older folks do) successful investing is about avoiding big mistakes. While this is most often associated with taking on too much risk, the reality is the biggest mistake investors make is not being invested for long-term success. We are much more confident in our market forecasts over the next few years than over the next few weeks. One of GreenPort's core beliefs is that investors should be invested at all times. We have, and expect to continue to, add value by tilting portfolios in favor of undervalued asset classes. However, at no point will we recommend not being invested. Before signing off, and sticking with the theme, it's been a while since we've done a movie review. Ford vs. Ferrari – While you may not love this movie, you’ll be hard-pressed not to like it a lot. Matt Damon does a solid job playing the role of Texan Carroll Shelby, the vision behind the Shelby Mustang that challenged Ferrari at LeMans. Christian Bale once again proves he’s the most versatile actor of his generation (sorry Joaquin Phoenix). If you are an automotive buff you will certainly love this movie, but there is still plenty to like about this movie even if cars aren’t your thing. We will see you at the movies, The GreenPort Team