As we look forward to welcoming the new year, I think it’s useful to reflect on the year past and see if there are any lessons we can learn. Here’s my take on the 5 big lessons from 2019 and what they mean for 2020.
1. Don’t fight the Fed
Unquestionably the biggest lesson from 2019, when the US Federal Reserve (the Fed) changes tact on monetary policy, markets respond. Globally. And if you aren’t on board or choose to ignore it, you do so at potentially a huge cost to your portfolio.
This year’s global equity market rally was so much down to the Fed. In fact, they first started to use the word “patience” on December 18, 2018 when the market was expecting interest rates to be hiked three times in 2019. By October, they had cut US interest rates three times.
Lower interest rates means that shares are more attractive relative to other assets such as bonds or term deposits. Further, interest costs reduce for companies, and over time, encouraged by lower interest rates, consumers spend more and purchase bigger ticket items. This in turn lifts demand and helps companies increase profits.
Interest rates down, shares up. Interest rates up, shares down.
This is a little simplistic, and there are of course other factors that influence sharemarkets. But when the US Fed changes tact, it can have a huge impact on markets.
Looking ahead to 2020, the Fed seems to be on hold. The next move, either up or down, could really set the tone.
2. Rate cuts don’t always work – but they do motivate investors!
The second lesson relates to the first in that while cuts to interest rates can be slow to have the desired economic effect, they certainly motivate investors to act. Somewhat surprisingly, the Reserve Bank of Australia (RBA) cut interest rates three times in 2019, taking the cash rate to a record low of just 0.75%. And did this motivate yield hungry investors – with the prices for the so called “expensive defensives”, stocks such as Transurban, Sydney Airport, APA, Coles, utilities and the property trusts, rallying hard.
There is discussion that interest rates could fall again in 2020, with the RBA Governor saying that he would be comfortable in taking the cash rate to just 0.25% before he would contemplate less conventional methods to stimulate the economy. This suggests that “expensive defensives” will remain expensive.
3. Certainties aren’t always certain
The certainty of 2019 was that there would be a change of government in Australia on May 18. Like Brexit and the US Presidential Election, the market and almost every commentator got this wrong.
I am not sure what the “certainty” of 2020 is, but the lesson is that markets are very forward looking and quick to price in what they expect to happen. If it doesn’t, there can be a material reaction the other way.
So, if you want to act in anticipation of an event, do it early because you can guarantee that the market will price it in. Your better strategy can often be to do nothing and wait.
4. There is a premium for growth
In 2019, we saw a huge premium being paid for companies that have genuine and consistent top line sales growth. Pricing multiples expanded considerably on companies such as CSL, Resmed, Cochlear, Macquarie, Xero, REA, Seek and Afterpay.
This is in part a response to the fact that so many of our major companies are “growthless”. The major banks, insurance companies, Telstra, Woolworths are low single digit or zero growth at best, while our major resource companies are price-takers and wholly dependent on a lift in commodity prices for revenue growth. Also, we are following the US where revenue growth tends to be more highly valued than pure earnings growth, which in the short term can come from cost cutting.
I think this is going to continue in 2020 – the quality growth stocks will get even more expensive.
5. Diversification matters more than ever
“Don’t put all your eggs in one basket” is one of the best known investment adages. However, in an environment of ultra-low interest rates where returns are compressed due to investor demand, it matters more than ever.
To maintain our income, the temptation is to seek out higher returning investments. This means taking on more risk. Now, there is nothing wrong per se in taking on more risk, as long as we appreciate that the likelihood of one or more of our investments going bad has increased. To minimize the impact on our capital, we should diversify and spread the risk.
In 2020, having a well-diversified portfolio of investments will matter just as much as it did in 2019, and probably more.
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