2019 was an extraordinary year for stocks with the S&P 500 (NYSE: SPY) gaining nearly 30% and breakouts to new, all-time highs for major indices across the globe. From a pure price perspective, these trends have carried over to the new year.
And there are certainly some good reasons to expect 2020 to be another positive year for equities. Election years for incumbents tend to be mildly bullish with an average gain of around 7%. Seasonality worked spectacularly in 2019 in terms of matching historical patterns of strong Decembers when stocks are up big on the year and strong performance in the third year of the first presidential term. Further, the Federal Reserve is quite dovish and has no intention to hike into a contentious election. Any concern that inflation could force the Fed's hand seem more unlikely given recent softness in wage growth and manufacturing. In fact, another rate cut seems more likely.
The S&P 500 is a bit more than 3% higher. Stocks with high short-interest readings are seeing explosive, exponential gains regardless of fundamentals like Tesla (Nasdaq: TSLA), Beyond Meat (Nasdaq: BYND), and Virgin Galactic Holdings (Nasdaq: SPCE). Mega-cap technology stocks like Microsoft (Nasdaq: MSFT) and Apple (Nasdaq: AAPL) continue to lead the market higher, dragging the indices with them. Enterprise and software as a service stocks are also continuing to see accumulation and breakouts.
Examining the Risks
However, there are some more subtle developments in 2020 that indicate some sort of distribution taking place under the surface which reveal some greater stress under the surface. Basically, there's no sign that economic growth has bottomed out. Most of the rally in 2019 was about the Fed moving from its hawkish stance to a dovish one. This is evident from the strength in dividend-paying stocks and weakness in cyclical stocks.
From October, stocks began to price in the possibility of an uptick in economic growth and turnaround in manufacturing with the primary catalyst being the trade deal between China and the US. After more than three months, the economic data is not confirming this hypothesis. And even price action in cyclical stocks is showing slippage.
This is not evident from simply looking at broad-based indices, but it's clear from looking at the price action of stocks more connected to the actual "real" economy rather than the "financial" economy. Examples include Caterpillar (NYSE: CAT), U.S. Steel (NYSE: X), and oil (NYSE: USO).
Play Defense
So despite the positive seasonality, momentum, and frenzy in stocks, market participants are advised to play defense. Stocks priced in a recovery over the last four and a half months which has not materialized. Once this momentum-fueled run subsides, the downside could be quick and nasty.