The stock market this year has started on an upward trajectory, continuing to ride a wave of momentum that propelled the market throughout the past year. The trends and factors behind this momentum remain in place and continue to push the market higher; however, the remarkably strong pace and consistency of the bull run may also now limit its further growth as significant upside is now priced in. Furthermore, significant potential headwinds and lurking risks may pose a major challenge to market growth in 2020. While we believe there is still upside to be had this year, the growth is unlikely to come close to the strong performance we observed last year.
Markets enjoyed a boost in January from the continuing momentum of the holiday rally. One of the major factors in the current leg of the rally has been a reduction of risk including the agreement and signing of the phase one trade deal in the US-China trade dispute as well as a successful Brexit deal. Solid jobs numbers and a strong start to earnings season continue to reassure investors that the US economy remains on a growth track.
Early in the month, the market was able to power through some headwinds including the US assassination of top Iranian General Qasem Soleimani. While markets sank on fears of geopolitical destabilization, they quickly recovered once it seemed both sides were not interested in further escalation. However, the market was hit hard by the growing health emergency of the Wuhan coronavirus, a potentially deadly flu-like illness that has managed to spread to multiple countries outside of China. The scale of the emergency has already shut down a massive amount of economic activity that would normally occur during the Chinese New Year holiday, and threatens to be a drag on international commerce, travel and economic conditions around the world. This had a correspondingly large effect on markets, briefly erasing their gains for the month. Going by historical examples, the effect of this outbreak on markets will be largely short term and markets should recover.
On balance, the trends currently influencing the market lean positive. Many of these trends arose or persisted in prominence throughout the last year; and of particular note is the fact that several of these trends reached a critical point very recently in December and resolved favorably for the market, creating a strong boost that is still being felt now.
Comparing today’s market to one year ago, there are some important differences that are useful for framing our expectations this year. Last January stocks were just coming out of the depths of the 2018 downturn and the market was pricing in a potential recession. Once the recession fears subsided, the market had a great deal of headroom to run higher, and the rebound acted like a rubber band, helping propel the market to the heights it reached in 2019.
In contrast, at the start of 2020 a lot of good news has already been priced in. Investors have optimistic expectations for future progress in trade negotiations, continuing low interest rates and further growth in corporate earnings that will eventually catch up to stock prices. There simply isn’t as much room for a dramatic market upswell because everyone already expects the market to reach loftier heights. The market has a much lower ceiling this year compared to last, and will find it much more difficult to put on the same kind of performance. This puffed up market also means future headwinds or risks carry more weight and have a greater chance of derailing the market into a pullback.
The market’s positive slant but diminished potential mean there isn’t a strong trajectory in either direction for the year ahead. The market is likely to be particularly sensitive to news and developments which will ultimately determine how the year ends up. While there is a lot that cannot be foreseen, many major market influences are likely to come from four broad categories: the domestic and global economy, as well as US politics and international geopolitics.
Overall, the market maintains a slight upward trajectory, but the array of potential future influences skews towards the negative. This means general outlook for the stock market is largely in neutral territory with potential for a modest gain in the 5-10% range. This outlook is somewhat soft due to the market’s susceptibility to new developments and influences which could knock the market off course. The potential impact of an upside surprise is limited due to the market’s diminished ceiling this year; however the downside risk is somewhat greater, with the potential to put the market into negative territory at year’s end.
The foundation of our trading strategy is designed to be able to generate returns whether the market goes up, down or sideways. The uncertainty surrounding the market’s ultimate direction in 2020 means a market neutral strategy such as ours will be important to ensure investment growth this year. For Lockbox Capital, the limited upside is also a useful guideline to help inform our trading thresholds, and the heightened potential for downside surprises is likely to open more volatility opportunities for us to take advantage of. Improvements in our analysis over the past year have also given us a greater degree of modeling accuracy and give us a further edge in our trading strategy that will enable us to deliver a strong performance for our fund at Lockbox Capital.