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The Bull Market Roars into the 20's


KEY POINTS:

· Market charges to new highs, as the S&P 500 ended the year at 3230.78, up 2.86% for the month of December and 28.88% for 2019. The Dow Jones closed at 28,534.44, up 1.74% in December and a gain of 22.34% for the year.


· The S&P 500 ended the decade up 256% (total return) for the last 10 years, with an annualized return of 15.27% (total return), leaving the recession and doom mongers scrambling for a hint of a chaos.


· Key catalysts for the late-year surge were the tariff truce with China and the Fed putting its pen down and staying put on interest rates.


· Technology, Communication Services and Financials led all sectors in 2019.


· Small recovery in bond yields calmed the bond market.


· Nice recovery in European and Emerging Market stocks late in the year as they paralleled the U.S. spike, but they are still undervalued compared to the U.S. market on a longer-term basis, but also more fragile than our stock market.


· Election rhetoric is heating up as the Democrats scramble to find an identity and a candidate. This will weigh more on the market next year depending on how their scale sways (overly progressive vs. moderate).


· Gold and some of the other metals had a good year as they were targeted as a safe haven during the volatile summer months when the tariff threats rose.


· 2019 will also be known as the most highly anticipated IPO market that created many overvalued newbies that quickly got lower valuations and toppled, led by UBER the most expensive company.


· PE ratio for the market is slightly high, above 20%, but it’s not that overvalued since we are in a low rate environment. We will need to see a recovery in earnings growth in the 5-10% range in order to keep the ratio in line.


· Risks for 2020 will continue to be the ongoing tariff negotiations, the election will become more of a threat if a left-leaning candidate wins the Democratic nomination, and now, we have the recent uptick in threats between the U.S. and Iran after the attack on Iran’s Quds Force leader Suleimani. The Fed is not as much a concern as they have stated their passive stance as a spectator.


· We project 10-12% growth in the S&P 500, in 2020, if we see a rise in corporate earnings growth (5-10%). We would also need a Biden, Bloomberg or Trump win to ease any market fears. The talks with China and ongoing phase deals must continue on pace. Obviously, any unforeseen Middle East tensions would create some volatility in the market, which shouldn’t last long. The BREXIT decision at the end of this month, might cause similar volatility.


Commentary:

Last year will be remembered as the year that surprised everyone with a 28.88% return, or maybe it was just that the market fell back on track after being wildly diverted by the Fed hike in Q4 2018. As a matter of fact, the high (closing) of the S&P 500 on 10/03/2018 was 2939. If we calculate the return from that date until the end of 2019, the market was only up 10.40% (see chart A), which is quite average. But we faced a -19.6% dislocation of the market in Q4 2018, after the Fed announced its rate-hiking strategy and the initial stages of the tariff war began. So, in reality the 28.8% is not that much of a surprise or out of the ordinary. It was just the market pressing reset and continuing its bullish path with an economy that is pushing its expansion as far as it can, as the U.S. stock market continues to be the best place to invest.

CHART A: S&P 500 (Oct. 2018 – Dec. 2019)

Source: AETOLIA CAPITAL & KOYFIN

We continue to believe that this bull market has more room to run. As we have previously stated, one could argue we are still in the bull market that started in March of 2009 (S&P low of 666), or that we have had several 20% corrections since then and that was enough to reset any market frothiness. So, its possible we just began another new bull market at the end of December 2018. Our economy is still strong, U.S. corporations are solid and cash rich, rates are incredibly low, unemployment is low, the consumer is spending with confidence and that is a vibrant environment for modest growth. We won’t be seeing 28% returns in 2020, that’s for sure. But we won’t be upset if we do. It’s difficult to project further than a couple of years out, as nobody can foresee the unknowable risks ahead. We can state the obvious that tariffs will be a continuous dark cloud over the market for many years. But Xi and Trump are showing an interest to work together on some minor details as its in both of their interests. The Fed has stated many times that they are on sabbatical and just watching things. The recession fears are quite low. And its not surprising if we see a couple of 5-10% corrections if the market keeps going higher and earnings are not catching up, creating an overvaluation of the overall market. We are definitely near the top of PE levels. The denominator of the P/E ratio needs to edge higher to keep valuations in a logical range. The low rates make it more plausible to maintain a slightly higher PE though. We are expecting a 10-12% return in the S&P 500, as we feel there will be some earnings surprises.


Looking at FactSet earnings projections:

· Current Year (CY) 2019 is expected to end of at 0.3% earnings growth once Q4 reports.

· Expectations are for a CY 2020 of 9.6% earnings growth, with Q1 coming at 5.0% and Q2 at 6.6%.

· Forward PE of the S&P 500 is 18.3.

· FactSet bottom-up end-of-year target price for the S&P 500 is 3441.44 or 5.6% higher.


We expect, as FactSet does, that U.S. multinationals with a majority of their revenue coming from overseas sales will see higher earnings growth. The strength of the dollar will play a role here. Of course, this represents most of the larger corporations. We feel technology will continue to lead as we start to get closer to a full-blown 5G rollout which will take several years to occur. As our robots and computers learn to function more on their own, we will see many new innovations and disruptive technology being introduced by new companies. Now the bad thing is that leads to elimination of many jobs. So, we are quite bullish heading into the new decade. Now will this be another "roaring 20's", we are not sure how long this momentum party will last.


S&P 500:

The S&P 500 was controlled and steered by Fed rhetoric and tariffs in 2019. We won’t repeat all of the comments we made during the year about these two factors. But the chart below highlights the “zig-zagging” we did last year, based on whether the Fed was going to cut rates or not, and whether we would see an increase in tariffs. We eventually got a phase one deal with China that is expected to be signed on January 15th. Hopefully we will not have these two issues play such a major role in the 2020 market, and we don’t expect it. The Fed continues to state their passive stance to view and not act on interest rates. We predict that the probability of a rate cut is slightly higher than an increase. All global markets know that they have Central Banks watching their backs and that they would step in to cut rates or purchase debt if needed. This addiction will continue until its not possible. This means that there is a limit to what Central Banks can do as a savior. We hope that we never see that point and that we can maintain this low growth rate environment.

CHART A: S&P 500 (2019)

Source: AETOLIA CAPITAL & KOYFIN

If you have any questions or comments, please contact me.


Regards,


John Anagnos

Managing Principal

Chief Investment Officer

AETOLIA CAPITAL LLC

3828 Kennett Pike

Suite 212

Greenville, DE 19807

Office: 302-543-4446 Fax: 302-510-4166

john.anagnos@aetoliacapital.com

www.aetoliacapital.com


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