We started the year with optimism that 2019 would represent a bounce back year from 2018’s bear market. I think we can safely say that the market did more than just bounce back; it took off. The S&P 500 finished up around 30%. We were up 30.7% in our managed account. What caused this to happen and what’s next?
We think it is appropriate to say that the bull market that started on March 9 of 2009 is the most hated we have seen in our careers. How can you hate a market that has gone up over 400%? By not owning it! Peter Lynch wrote in one of his books, “More money has been lost preparing for a recession than the actual recession.” We believe that to be true with this market. We can understand why investors would not want to own stocks for a while after the disaster that was the Great Recession of 2008. Seeing a market decline over 60% will cause fear in the most hardened investors. What is surprising to us is how this negative sentiment won’t go away 10 years later.
Barron’s did a survey in the fall of big money investor sentiment. Here is what they said,
“After a big year for U.S. stocks—make that a big 10 years—America’s money managers see trouble ahead for investors. Blame it on the market’s lofty valuation, a muddled economic outlook, or the increasingly fractious political landscape, any of which could stifle stocks’ advance in coming months. Whatever the case, only 27% of money managers responding to Barron’s fall 2019 Big Money Poll call themselves bullish about the market’s prospects for the next 12 months, down from 49% in our spring survey and 56% a year ago. The latest reading is the lowest percentage of bulls in more than 20 years.”
When you have a 20-year high or low in investor sentiment, it generally means that you should bet on the opposite of what the majority thinks. In 2019, that logic paid off again. After that survey was taken, the president was impeached, a mini trade deal with China may or may not happen, manufacturing sentiment was negative, the yield curve was inverted because of recession fears and yet stocks went to new highs. Why?
We have repeatedly stated that the most powerful man or woman in the financial markets is whoever is running the Federal Reserve of the United States. The action of the repo market in September was proof that still holds true. The repo market is an obscure place for most investors. We won’t get into the plumbing of how it works other than to say it helps fund Wall Street and the U.S. government’s borrowing needs. Starting in September, the interest rate on repos went above the interest rate range the Fed wanted it to be at. Instead of the rate being 1.5% to 2%, it was over 8%. This surge in interest rates indicated that there was a huge shortage of cash available to fund the banks and Wall Street’s funding needs. To alleviate the “cash squeeze” going on in repos, the Fed started injecting billions of dollars into the system. The stock market started to go up from there and didn’t look back.
Wall street is estimating that the Fed is going to inject around $500 billion into the repo markets. It is our opinion this is the start of quantitative easing 4 (QE4). Wall Street loves it when the Fed throws money at a problem, and this time was no different. What we found interesting at the start of QE4 is that value stocks and commodities started to outperform growth stocks for the first time in quite a while. We own a bunch of both, and it helped our accounts beat the Dow and S&P 500 this year. When does this end?
The Fed can print all the money it wants to boost asset prices (stocks and bonds) until there is inflation. At that point they have difficult decisions to make: fight inflation or let the economy run hotter. It has been our opinion that the Federal Reserve THIS TIME is going to let the economy run above its 2% inflation target before trying to stop it. What the Fed did in the repo market this year reaffirms our belief. Even with the economy at record low unemployment, stocks up 20% for the year, the Fed decided to print more money in September to boost the economy. This is very rare. Hence, you had a year-end rally in stocks that was one for the record books.
We think the end of this bull market comes when either the dollar goes lower, inflation picks up, or more likely both. If the dollar declines it will help value stocks more than growth stocks but at the cost of losing the support of the Fed. There is a lot of foreign money in this market that we think bought growth stocks. Should our currency decline, we think foreign investors will be net sellers of the growth stocks they have been buying.
We want to point out how some of the stocks we owned did this year. The winner for best return of the year was Maxwell Technologies. It started the year at $2.07 and finished at $8.07. Along the way it was bought out by Tesla. Elon Musk’s company had a great year and it helped our portfolios a lot. Royal Gold started the year at $85.65 and went up 42.4% to $121.97. Apple Inc. started the year at $157.74 and finished at $293.65 (a gain of 86.16%). The last stock we want to highlight is Newmark Group. It was one of our worst performers last year, and this year it went up 67.7% ($8.02 to $13.45).
Stocks that didn’t do as well this year were two of our three largest holdings, Berkshire Hathaway and CenturyLink. Berkshire was up “only” 10.93% while CenturyLink’s total return was -6.3%. BGC partners total return came in at 39.7%. We view each of these stocks as very undervalued at their current prices. We think they will help carry out portfolios over the next few years as our winners cool off some.
We want to close this letter by writing about CenturyLink, our worst performer this year. In our second quarter report (it’s on our web-site for July 1, 2019, Emotional Markets) we wrote about how a stock being up year-over-year causes momentum investors to buy more of that stock, not less. We mention this because most of our stocks will now be up year over year on December 31. The one exception is CenturyLink. At its present stock price, it will be up year-over- year in the third week of February. At that point we expect the wind to be at their back for the first time in two years. The stock qualifies as one of the cheapest stocks in the market, but the fact that it is not up year-over-year keeps the momentum buyers from owning it. CenturyLink also has a poison pill expiring in November, which limits how much large institutions can buy of their stock. Once that pill is lifted, it makes this stock a potential takeover candidate. This stock hasn’t been a lot of fun to own the last two years. The odds favor that ending this year.
Sincerely
Mark Brueggemann IAR Kelly Smith IAR Brandon Robinson IAR