Financial Forum January 2020
Market Commentary – Stocks Party into the New Year
What a difference a year makes. A year ago, December, markets dropped as investors were crippled with fear and pessimism about global growth and profits. In fact, at that time, the CNN Fear & Greed Index registered an extremely pessimistic reading of just five out of 100. Fast forward to this December and that same index is flashing a reading of 91, indicating nearly full-blown bullishness, usually a contrarian signal that some type of pullback may be forthcoming. Other sentiment indicators are also indicating excessive investor risk taking. Both the University of Michigan consumer confidence and Investors Intelligence surveys are showing extreme optimism. And just last week, Thomson Reuters reported that for every company insider (i.e. corporate executives, board members, etc.) that bought stock, a whopping 36 sold some shares.
So what caused this year’s fourth quarter melt up? Generally speaking, stocks grinded relentlessly higher into yearend on continued momentum from the positive resolution of four key events: A phase one trade deal, accommodative central banks, economic data that wasn’t getting worse (which implies stabilization) and a Brexit resolution. That positive momentum was amplified by the time of year (stocks typically rally into yearend) and the fact that there was no motivation to sell stocks in the short term and incur a big taxable gain. Let’s look at a couple of these below.
Phase One Trade Deal: Although details are very light, expectations are very elevated for phase one, as the deal is expected to (1) lead to a rebound in global growth which (2) causes gains in U.S. corporate earnings. The text of this deal won’t be released until mid-January. However, at some point, the market will demand that the details of the trade deal are credible towards accomplishing those two goals. Despite surging stocks, it’s not at all clear that it will. For one, earnings estimates for 2020 continue to fall. “Whisper numbers” for the S&P 500 earnings keep falling and are now expected to fall in the $173-$174 range, down from $175-$176. That means the market is trading at almost 19 times earnings; a multiple that is not acceptable unless global growth and profits do truly rebound as anticipated. Proof of these better earnings need to emerge in the Q4 reporting period, which starts in mid-January, otherwise valuations will become a concern.
Fed and Other Central Bank Policies: While trade headlines garner most of the media coverage, I believe the main reason for the market’s recent melt up was the Fed and other central banks’ accommodative monetary policies. In response to the Great Recession of 2008, central banks, led by the Fed, started printing money in the hopes that it would promote economic growth through lower borrowing costs and increased asset prices (i.e. stocks, bonds, real estate, etc.). Over the decade, there have been many charts showing an extremely high correlation between the increase in the Fed’s balance sheet and the rise in the S&P 500 index. Simply put, every time the Fed expanded its balance sheet through money printing, the S&P rose.
In Q4, the Fed was back in the money printing business (and with a vengeance). They printed more money last quarter than they ever did during the financial crisis. They just weren’t calling it their usual moniker of quantitative easing (QE). But make no mistake about it, it was QE. In response to a spike in overnight money market bank borrowing rates in mid-September, the Fed quietly injected over $300 billion into the banking system to bring stability back to the repo market. What started out as a program that was only supposed to last a couple of days, has expanded multiple times and is now expected to continue at $60 billion a month through the second quarter of 2020. Combine this with the European Central Bank’s $20 billion per month and the Bank of Japan’s QE and you have an annual pace of printing at over $1 trillion. Is it any wonder that some of this money found its way into the world’s stock markets causing a worldwide melt up?
Bottom Line: At these levels, the stock market has not only priced in a phase one trade deal, but also priced in secondary benefits from the trade deal meaning, we get clarity on global trade and some tariff reduction which, in turn, leads to 2020 S&P 500 profit estimates increasing. The increase in corporate profits, combined with lower rates and central bank stimulus, leads to the ultimate endgame - an increase in global growth. While this could certainly happen, it does pose a big risk for the markets. If phase one disappoints or doesn’t have the desired reflationary effect, then we’re not just dealing with the fallout from that one event, we will also have to deal with the fallout from no increase in earnings expectations and renewed concerns about a global slowdown that could pull the U.S. in with it.
Wealth Management – The SECURE Act
The most sweeping changes to the U.S. retirement system in more than a decade was signed into law last month. The “Setting Every Community Up for Retirement Enhancement” Act legislates a host of new rules that will affect retirees and savers, ranging from withdrawal strategies to 401(k) options, to required minimum distributions (RMDs). Due to space constraints, we have highlighted a few of the legislation’s more relevant points. In future writings, we will provide more details, as well as, new planning opportunities. The new law takes effect on January 1, 2020.
Stretch-Out IRAs: The new rules say beneficiaries of retirement accounts, such as IRAs and 401(k) plans, need to withdraw all of the money out of those accounts within 10 years, instead of over their life expectancy as was previously allowed. There are no required minimum distributions within that time frame, but the account balance must be zero after the 10th year. The new 10-year rule only applies to accounts of benefactors who die in 2020 and beyond. Current beneficiaries of inherited IRAs and 401(k) plans will still be allowed to withdraw the required minimum distributions over their life expectancy. Additionally, the rule does not apply to spousal beneficiaries, as well as disabled beneficiaries and those who are not more than 10 years younger than the account holder. Minor children are also exempt, but only until they reach majority age. After that, they will have 10 years to withdraw the assets in an inherited account.
Required Minimum Distributions (RMDs): Previously, qualified account holders, such as those with a 401(k) or IRA, had to withdraw RMDs in the year they turned age 70.5. The SECURE Act increases that age to 72 for anyone who turns 70.5 starting in 2020. Americans who turned 70.5 years old in 2019 still need to withdraw their required minimum distributions this year and all future years. Failure to do so results in a 50% penalty of the RMD shortfall.
The bill also eliminates the maximum age for traditional IRA contributions, which was previously capped at 70.5 years old.
Quarterly Thought – Happy New Year!
All of us at Pinnacle Wealth Management Group, Inc. would like to wish you and your family the happiest and healthiest of new years. The best is yet to come…
Pinnacle Wealth Management Group, Inc.
Securities offered through Private Client Services, Member FINRA/SIPC. Advisory products and services offered through Pinnacle Wealth Management Group, Inc., a Registered Investment Advisor. Private Client Services and Pinnacle Wealth Management Group, Inc., are unaffiliated entities.