Market Commentary – December 2019
“Knowledge is knowing that you know nothing” – Socrates
What a difference a year makes, in our December 2018 Market Commentary, our title read “Limping through the tape”, which was appropriate as the US stock market experienced its worst December since the Great Depression. The 2019 US Equity Market was a throw-back to 2017 where we experienced very little volatility throughout the year with a melt-up/FOMO chase in Q4 for year end performance. For the US equity market 2018 was characterized by a sizable jump in earnings due to the lowering of corporate tax rates (2017 Tax overhaul) but a contraction in Price to Earnings (PE) multiples. 2019 has experienced almost zero earnings growth while we have seen the PE multiples expand handily – go figure. Just when you think you “Know” what the market is going to do… it does the thing to make the largest number of people look foolish.
Most of our equity portfolio performed well in 2019 with the notable winners being Apple, RH, Facebook, Disney. Apple was up 86% in 2019 – adding over 500 billion in market cap value last year alone. What’s even more amazing is it made this huge gain after dropping 38% in Q4 of 2018. While the 38% sell-off was an over-reaction, should Apple have been up 86% in 2019 when it has absolutely flat earnings growth year over year? RH was a new addition to the portfolio in 2019. Restoration Hardware was rebranded 2 years ago to RH as the company made a massive shift in their strategy from mall-based stores that sold really expensive furniture and eclectic trinkets into “Galleries” that sell upscale housewares, provide in-house designers free of charge and have created a “Third Place” as Starbucks describes it for people to come and hang out. We believe the shift in strategy is going to allow RH to become a dominant player in the upscale home furnishings market not just in the US but globally… and Berkshire might agree as they recently announced they have bought over 6% of the company’s stock (Per Q3 holdings disclosure). Facebook was a case of a bounce-back story ala Apple in 2019, but unlike Apple, Facebook has yet to push through to new highs. Disney which had been treading water for the last 3 years finally bolted to new all-time highs on the successful launch of their Disney+ Service. What we believe is the real upside for Disney is the data they are going to gather from the users of the Disney+ platform. This has been a huge boon for Netflix over the years, we just have never been able to get comfortable with their debt load and valuation.
Anyone that has managed money also knows sometimes your thesis is just flat wrong the two main investments that fit that mantra where Virtu Financial and Occidental Petroleum. Virtu was a classic case of two issues 1) Not properly understanding the competitive dynamics around that business 2) Having a year where volatility got crushed – something this company needs in order to drive profits (They handle trading flow for computerized trading). We took our tax losses in taxable accounts to use against cap gains and have sold out of most of the IRAs as well. We predict we will have zero allocation to the name by the end of January 2020. Occidental is a name we still believe in, we just should not have gotten involved in the stock until we were certain that they were not going to buy Anadarko Petroleum. While we sold our allocation in December of 2019 to harvest tax losses in our taxable accounts, we will not only be adding back but will be doubling up our allocation to the name in January for 2020. Energy stocks have traded back to the 2008/2009 lows, which in our opinion is ridiculous. With inflation starting to finally percolate we think investment in Energy may finally have a chance to make investors some money here in 2020. We like that we also get paid to wait with a dividend north of 7% which is currently covered by the company’s cash flows. The final cherry on top is the fact that we think Occidental might be an acquisition target in 2020. Chevron wanted Anadarko’s assets which Occidental bought. Occidental now has the #1 acreage position in the US Permian Basin, something that Chevron and other producers greatly covet – along with the ownership of their own pipeline assets to get the oil to market (A major issue at current in the Permian). We believe Carl Icahn, who still has a billion-dollar position in the stock will be putting a lot of pressure on management and the board to create value for shareholders, who had to suffer a 40% draw down in stock price during the course of 2019.
On the fixed income front if you owned lower credit debt or longer-term bonds, you were handsomely paid last year as the economy didn’t recess and rates fell for the first 9 months of last year. In both cases, we don’t think taking either credit risk or duration risk again in 2020 will properly compensate investors for those risks. We continue to keep our allocations mainly high grade (Treasuries, Munis, Corporates, Mortgaged Backed) and fairly short term in nature. We prefer to keep our fixed income portfolio available for better buying opportunities that could develop in equities or real estate as we move forward.
As we wrote about mid-year we added two different Real Assets to the portfolios of our clients in 2019. We believe both Real Estate and Gold are displaying strong risk/reward characteristics on a go forward basis and we may look to opportunistically increase our allocations to both buckets.
We are hopeful for another successful year in 2020, but caution our investors that every year tends to display its own independent characteristics. 2019’s winners like tech may continue to win, but the higher prices go without commensurate earnings growth to follow, investors need to be mindful that a strong give back in this part of the market is possible in 2020. Conversely an area like Energy may finally be in a place to give investors better forward returns as sentiment is at rock bottom, while underlying fundamentals for the sector look to be improving. Finally, volatility has been very depressed of late which could mean investors are very complacent at current – one thing we’ve learned over the years, although the market keeps powering higher, risk unfortunately can sometimes happen all at once.
Koa Wealth Management
11260 El Camino Real, Unit 220, San Diego, CA 92130
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