2020 Outlook

The Digital Divide Intensifies

The financial markets have much to cheer about in 2019. As of December 9, 2019, the S&P 500 has returned 27.5% year-to-date including dividends, and the S&P U.S. Aggregate Bond Index 7.3%. As 2020 nears, we continue to be constructive on both stock and bonds, albeit with a continued focus on corporations that demonstrate a competitive advantage, financial flexibility and digital capacity. Corporate profitability growth will become increasingly tied to these three core competencies, in our opinion. At a forward price-to-earnings multiple for the S&P 500 Index of 17.7 times on estimated 11% operating earnings growth for 2020, valuations are above-average relative to the last 25 years based on JP Morgan research. We believe earnings growth will become a greater driver of any upward price movement than valuation expansion. We do not anticipate a large move up or down in interest rates, so long as unemployment and inflation remain within the Federal Reserve’s target range and international markets are stable. The historical stability of bonds offers potential balance with some income for portfolios.

Consumer Confidence

As we close out 2019, the approximate two-thirds of U.S. gross domestic product (GDP) comprised of consumer spending is set to the end the year with a bang: shoppers in the U.S. spent an average of $361.90 over the 5-day Thanksgiving holiday, up an impressive 16% from $313.29 in 2018, and the number of shoppers reached 189.6 million, or approximately 14% more than in 2018. The National Retail Federation continues to forecast holiday sales (November to December)  growth of between 3.8% and 4.2%, up from 2.1%. As Exhibit 1 below shows, both consumer confidence and consumption are benefitting from strong employment numbers.

We believe U.S. economic growth will slow in 2020, with corporate profit growth accruing to fewer companies. Those companies that have invested in technology to deliver more for less to consumers, as well as having the capability to offer multiple delivery platforms, will, in our opinion, garner more of the consumer dollar, be that discretionary or nondiscretionary. Low interest rates, slow growth, a strong job market, and pent-up demand combined with high U.S. public debt are just the catalyst to further widen the gap between the “haves” and the “have nots” of corporate America.

Corporate Commanding Heights
The “haves” of corporate America are firmly rooted in a growth continuum that includes consistent and sufficient digital capital investment to grow in a world  that  requires “more with less”.  We believe that those companies across industries that have invested to take advantage of the trajectory embracing the digital transformation are just at the cusp of breaking away from those on the non-digital or limited-digital legacy systems trajectory. The retail industry has offered a glimpse into the path forward for other industries.

Amazon, Target, Walmart, and Costco have accumulated increasing share of the consumers’ wallet by giving the consumer everything they want – both in product and shopping experience. Toys R Us, Forever 21, Payless ShoeSource, and Sears are just a handful of the retailers that have filed for bankruptcy protection over the recent past. They failed to sufficiently invest and prepare for this digital transition, which was magnified by global competition and slowing economic growth. Many of their stores sit empty today.

Another example of this trend toward consolidation is the just announced “take under” of Diplomat, a specialty pharmacy and infusion servicer, by United Healthcare. The lack of financial flexibility, as well as lack of bargaining power with pharmacy benefit managers, has led to both profitability and balance sheet erosion, which, in turn, has caused the firm to violate its debt covenants.

The stock  was trading above  the to-be-announced purchase price, and thus, declined on the announcement. We anticipate increasing speed and breadth of the digital divide to reach across industries
in 2020.

Below we reshare a chart from our June 2017 Investment Update. As we look to 2020 and share our outlook, we continue with our long-term investment strategy that has focused on the enduring corporate qualities that we believe will serve our clients’ portfolios well during both strong economic periods, as well as less robust periods.

2020 Outlook

As we crossover to 2020, we are optimistically cautious. We anticipate slowing U.S. and global economic growth as the most likely scenario. We believe interest rate changes will be muted and stock valuations will be driven increasingly by corporate profit growth, rather than valuation expansion. Lastly, we expect geopolitics and the upcoming U.S. presidential election to add volatility.

Thank you to our clients, business partners and all those we have the opportunity to connect with. We appreciate the opportunity to serve and work alongside you. We look forward to 2020.