The stock market defied gravity in 2019 and rose by almost 35 percent, which is the highest annual return in 10 years. Climbing a wall of worry is an old saying on Wall Street that describes how a strong stock market can handle or even be spurred on by bad news. This describes 2019 very well.
The end of 2018 struck a dull note as stock exchanges fell steeply right up until Christmas, and the market worried about a slowdown in the global economy on the back of a trade war and rising interest rates. However, thanks to a U-turn by the Federal Reserve in a very final days of 2018, a striking reversal of the trend set the scene for a fantastic year for stock markets.
The knowledge that the Federal Reserve was not going to continue with interest rate hikes and planned instead to begin a new wave of cuts made the market basically immune to bad news. After a total of 9 increases between the end of 2015 and 2018, the Federal Reserve cut interest rates in three steps 3 during 2019 to the current 1.75 percent. The US-China trade war took many turns during the year, creating clear real effects on world trade, and the WTO, for example, downwardly revised its growth forecast for global trade volumes in October to 1.2 percent from 2.6 percent in April. Leading economic indicators in the form of global PMIs indicated declining growth for 6 months, and the fixed income market priced in an upcoming recession when long-term interest rates were traded below the repo rate for a time. Some cyclical companies certainly fell back due to the economic concerns, but the stock market as a whole did very well as investors instead bought defensive companies, companies whose growth was generally considered to be resistant to economic worries, or companies whose business models were generally considered robust. In this context, valuation became almost irrelevant in decision-making. The return on the alternative – the fixed income market – was and is close to zero, so investments that were made attractive by some kind of additional return were like hot cakes on the stock market. The performance between sectors and even individual companies differed widely during the year, as did valuations. This was sometimes very challenging for us since we focus on active management. Traditional valuation principles no longer applied as already expensive companies were allowed to become even more expensive, while cheap companies continued to be ignored by investors. However, this has probably created a number of very interesting investment opportunities for an active investor, with the opportunity to take positions for both ups and downs in individual companies.
Hedge funds have had a tough time over a number of years of strong stock markets and falling interest rates. The asset class has been outcompeted by simpler index tracking products that have generated good returns at a low price. But is it now time for a comeback? The stock market has now priced in a great deal in advance, and many valuations are sky-high compared to the past. On the other side of the coin, undervalued companies that have for long periods in the past proven to be among the best investments have for many consecutive years underperformed the market and are now valued with bigger discounts than in a long time. In recent decades we have experienced some form of crisis in the stock market about every ten years, but it has now been an unusually long time since there was any really big correction.
Could it be time for less hectic performance? Time for market participants to start looking at valuations again?
Time to invest in hedge funds?