What an end to the year! The overall gain for the world equities index in 2019 was 28.1%, while the S&P 500 progressed 31% and the euro zone 27.6%. European investors in the US market would have made 35.3% in euros. Wall Street makes up no less than 63.7% of world market capitalisation, despite the fact that the USA accounts for ‘only’ 26.2% of world GDP. It says a great deal about this economy’s ‘financialisation’ and the massive margins posted by companies priced with a PER of 19.5. The 20% correction in equity prices that we saw towards the end of last year would normally have signalled imminent recession, which would have been logical given the trade war with China, rapidly rising interest rates and Brexit. On top of that, investors reacted by rushing into government bonds, depressing yields and forcing central banks to react. When recession failed to materialise, the absence of return on alternatives to equities triggered the strong reaction we saw this year. The best performers of all were American IT firms, which surged 47%; at the other end of the scale, the energy sector underperformed again. Apple gained 80% and Microsoft 57%, and between the two they accounted for 40% of the sector’s rally. Their combined capitalisation of [.4 trillion is not that far from France’s GDP of [.8 trillion. How far can this go, and how can these monsters be cut down to size? Monopolies on the GAFAM scale endanger innovation, as they end up merely protecting their own position. How much innovation has there really been between the first and the most recent iPhone, for example? And what about Google, where information has given way to unwanted, non-objective advertising?
Three rate cuts from the Fed have normalised the US curve and dispelled fears of recession. The US authorities do not expect to make any changes in 2020, so long as the economy remains on its current track and the PCE deflator sticks below 2%. They are projecting GDP growth of 2% or lower next year, while consensus forecasters are at just 1.8%. The trade conflict has hit manufacturing and business investment, but consumers have stepped in with increased spending of their own.
While our underweight equities position all year turned out to have been wrong, our aggressive exposure to real estate more than offset that decision. Real estate prices have soared worldwide, cutting the yields on new deals. Those yields are now below 3% on prime Parisian office space, for example. Coupling reasonable leverage with 1% loan rates drove returns above 30%. We put our cash in US Treasuries to profit from exchange rate movements and 2% interest. Hence the Dom Perignon!
Projections for world growth in 2020 are cautious. It is expected to slow from 2.7% this year to 2.6%, with the USA slowing from 2.3% to 1.8%. We would not rule out a positive surprise in the event of a calmer trade situation and a good agreement on Brexit. Profits will struggle to increase after a flatline 2019. Investors are wary, tending to sell equities in order to buy bonds. Corporate buybacks are keeping prices up. Our S&P 500 objective for the end of 2020 is 2,897 points, meaning a potential 10% correction plus a 2% dividend yield. Further increases in long rates are the big risk. We are maintaining our underweight allocation relative to our benchmark (35%) as well as our overweight position in real estate with cash invested in Treasuries.
We wish our readers a happy holiday period and all the best for 2020.
