How Long Can These Early Gains Last?

FYI | Jan 22 2020

By Peter Switzer, Switzer Report

In case you missed it, though you probably haven’t, this has been a great start to a stock market year, after a ripper of a one in 2019. The gain since the start of 2020 is 5.7% and the question many of you have to be asking is: “How long can this last?”

Since the middle of last year, I was telling you and our financial planning clients that I was prepared to back stocks on the basis that President Donald Trump needed a trade deal before the November election this year. The pressure of this impeachment for Mr Trump, and its possible bad election effects, means keeping his Wall Street customers satisfied is crucial. In a sense, he needs a bridge over troubled political waters, and a rising stock market and improving economy constitute the strongest political bridges he can make or mend before the end-of-year poll.

That said, I expected an eventual sell off and therefore I talked about being more defensive going into March or April on the basis that US electioneering could easily unsettle markets. Of course, this is speculation but it’s wise to remember the old market maxim: “Sell in May and go away, come back on St. Leger’s Day.”

Of course, it doesn’t always work out and St. Leger’s Day is in September. And by the way, the market often doesn’t turn positive until October or November. With the US election in the first week of November, there is bound to be a market holding of the breath until it sees whether Donald will ride again for another four years. The market would like a Trump win. Sure, he borders on the Twitter-crazy but he’s sensitive to Wall Street and talks the talk they like, such as lower taxes and less regulation, so he’d be a positive for stocks.

It’s also worth remembering that the fourth year of a US President is the second best behind the third year, which last year racked up a 29% gain! The one big threat to stocks is the Fed. The US central bank powered up stocks with interest rate cuts in 2019, when the market had been led to believe that there would be three rises. I’ll be monitoring the economic comeback of the US and if it gets bigger than expected, it could spark fears about inflation and rising interest rates. That would hit stocks if this kind of talk gets out of hand. I’ll be watching the Fed very closely for any signs that I need to go defensive but for now the signs look OK to remain long stocks.

Each Sunday I look forward to Percy Allan’s Market Timing email. Percy takes in a whole lot of quantitative and qualitative indicators to work out what market sentiment is pointing to. Despite the big year for stocks in 2019 and the great start in 2020, the latest readings are still very bullish. The chart below shows that Percy sees green lights for all the key markets he seeks to time, which says something worth noting.

“The Traffic Light is on Green when the Australian share market shows both positive short and long-term trends,” Percy explains. “It’s on Red when these trends are both negative. It’s on Amber when one of these trends is positive and the other is negative.” The fact his local stock market assessment is full on green, as shown by “Buy STW”, is a plus for anyone pondering if they should take profit and go full on defensive. (STW is the ETF for the S&P/ASX 200 Index that Percy uses.) But it’s not a full on positive story as Percy has two thumbs up to gold, suggesting that this is an insurance play for an inevitable sell off over 2020.

That makes sense, especially with Middle East problems around at the moment. However, I wouldn’t be going too long gold unless you believed there’s going to be a big stock market sell off/crash and geopolitical developments will be close to nuclear-scary.

Neither of these scenarios make my projected playbook for 2020.

At the local level, as I referred to on Saturday, the bush fires will bring big government and even private sector spending that will pump up economic growth, company profits and stock prices. Sure, the first couple of quarters will suffer from the fires’ effects on tourism, retail and construction but the repair spending will be a huge stimulus to the economy. After the tragic earthquakes, Christchurch saw an enormous boost to its economy. And it’s said that the state of Louisiana actually fared better during the GFC of 2008 because of the repair spending that came from the 2005 Hurricane Katrina tragedy.

When I try to work out my shorter-term investment strategy, I look for market-turning events and, at this stage, the really big ones — significant interest rate rises, a notable spike in inflation, a dramatic geopolitical drama or a serious global or local economic slump, look like lower order risks for 2020.

The one curve ball or potential black swan would be a financial market crisis linked to the excessive pile of debt out there. While I don’t like the accumulation of debt that has followed central banks’ attempts to kick-start economic growth since the fallout of the GFC, the fact we are seeing economic growth pick up in China and the USA is a real plus for stocks. It also reduces the concerns about a financial market meltdown. The worst-case scenario for markets would be too much debt and little growth to help pay it down!

I believe the positives from the phase one trade deal should reinforce US and Chinese growth and even help the Eurozone that relies heavily on demand from China. As you can see, I have a bias towards stocks this year again but I expect more volatility — scary moments — but the final score at year’s end should be a nice positive for those invested in quality companies.

One last point I’d like to make. For our financial planning clients, we show them what Tim Farrelly, a renowned market forecaster, thinks about certain markets. This is his 10-year view on Aussie stocks. On the chart below, you can see that the arrow (at 31 December) was pointing towards 6750 and Tim says our market was cheap. Fair value stretches from 7250 to 8250 (the All Ords is just below 7200 as I write) and overpriced doesn’t show up until we crack 10,000!

Of course, this is a long-term view of the markets but it does remind us that if we try to be too smart in the short term, the stock market can make a monkey out of us. When I look at Tim’s predictive work, it reminds me that we should be long-term investors. And the older we become, the more we should be harvesting dividends and franking credits because these have a lot more stability in a falling stock market than share prices.

Peter Switzer is the founder and publisher of the Switzer Super Report, a newsletter and website that offers advice, information and education to help you grow your DIY super.

Content included in this article is not by association the view of FNArena (see our disclaimer).

Important information: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. For this reason, any individual should, before acting, consider the appropriateness of the information, having regard to the individual’s objectives, financial situation and needs and, if necessary, seek appropriate professional advice.

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