Fears of a recession and bear market largely receded in 2019, giving way to a massive rally in the stock market last year.
One person that predicted this on our show in 2019 was Jim Paulsen, Chief Investment Strategist at the Leuthold Group, who gave us an update on his outlook for 2020. Here's what he told listeners in a recent interview with FS Insider...
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The 'Three-Gun Gooser' in 2019
The big drivers of the stock market last year included, one, an expanding money supply created by the Fed’s dramatic about-face, two, expanding fiscal stimulus and, three, declining yields.
What we saw as a result was a dramatic move higher in stocks as fears of recession gave way to economic re-acceleration, Paulsen noted, all of which he correctly predicted would goose stocks higher when we spoke to him in 2019 (see If There's a Recession It May Be Over, Says Jim Paulsen).
Another factor that helped substantially last year was the large year-end correction in 2018 that took many by surprise. The 20 percent decline and subsequently lower PE ratios gave markets a strong base upon which to build a rally throughout the year.
It also put some fear into the market, which allowed us to climb the proverbial ‘Wall of Worry,’ Paulsen noted, which is often a positive factor for equities.
We also dramatically lowered the competitive long-term interest rate, he added, with the 10-year yield falling from 3.25% in October 2018 down around 1.5% in 2019.
“On top of all this, we had the full policy support of officials, which I refer to as the calvary coming to the rescue,” Paulsen stated. “They were just as panicked as anyone else that the recovery was ending. And so they brought all three guns and applied them to the situation, not only here, but globally. The three-gun gooser has only existed about 15 percent of the time in post-war history and it’s typically brought out only when we're in a recession. … That’s a pretty good combo: much better valuations, a wall of worry, much lower rates and a full policy calvary support.”
Is the 'Gooser' Still in Play for 2020?
Paulsen told listeners that the three-gun gooser is alive and well, and still in force. We’ve had declining yields over the previous 6 months along with faster acceleration in money supply growth and deficit spending as a percent of GDP since last summer.
Looking back to 2019, sentiment was very similar to what we see in the first year after a bear market, Paulsen noted. Looking back to 1950 onward, all first-year bull markets are driven by the wall of worry.
Fundamentals also started to weaken in 2019, and earnings flattened out entirely, which is typical of the pattern, Paulsen noted. Typically we see a weak economy and weak earnings, driven by lower interest rates, greater policy support, fear and higher valuations and PE multiples.
In many ways, 2019 looked like the first year of a bull market, Paulsen stated. In fact, its full first-year gain was just shy of 30 percent, which is close to the average first-year gain of 10 or 11 bull markets we've had since 1950 in their first year.
“I'm not saying we’re in a fresh bull market,” Paulson said. “There’s no way we are. There's so many differences. We’re now in the longest economic recovery ever in our history. We've got the longest bull market ever in our history. We’re at full employment. There are many reasons why it's not a fresh bull market, but the character rhymes a lot with a fresh bull.”
Positioning for 2020
Paulsen believes we will start to see earnings numbers improve a bit with upside revisions and better commentary from CEOs on their outlooks.
Full Fed policy support is also likely to wane if this change comes into effect, he added. As economic data improves, we likely begin to lose the three-gun goose. The Fed may even pause quantitative easing later this year.
Fears of overheat and inflation will probably return, Paulsen noted. For now, he recommends staying bullish, though not at full-tilt in a balanced portfolio, with roughly 70 percent of assets allocated for bullish plays.
“I'm more worried at some point about the market dealing with real pressures,” he said. “Ultimately, every recession that has occurred in post-war history has been preceded by overheating pressures in the United States. Every one of them. That means inflation goes up. That means yields rise for a period. That means the Federal Reserve and other policy officials tightened prior to a recession. I think ultimately this bull will end that way too. We darn near ended 2018 like that and I think that we will, but right now there is no pressure like that. … For a period, I'm not looking for great downside risk. … Ultimately, if yields climb, maybe the Fed backs away from easing and we start to bring some real pressure that could be an issue maybe sometime this year yet, or maybe in 2021. We’ll just have to see how fast some of that comes back.”
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