Quarterly Investment Commentary


The turning of a calendar year as well as the passing of a decade are milestones that offer an important opportunity for reflection: a chance to take stock of the past and to look forward to the future with fresh perspective and purpose.

2020 welcomes you

But milestones come and go and it is important not to read too much significance into the milestones themselves relative to their place on the journey at hand.

This is especially true for investing, where too much emphasis can be placed on near-term events that often don’t matter much in the big scheme of things, nor in the context of most investors’ relevant time horizons. At the same time, too little attention is paid to things that may not seem newsworthy in the moment, but become very important in time.

For us, we like to use every calendar year-end as an opportunity to zoom out for a broader look at our assumptions about where things have been, where they are, and where they are likely headed.

Changes afoot

If you step back, you can see that a remarkable amount has changed in the world over the past two decades. This includes significant population and economic growth, transformative technological innovation, major geopolitical and demographic shifts, rising income inequality and climate change. We have also seen terrorist events, wars and military conflicts, economic bubbles and recessions.

Yet despite some significant setbacks, global GDP growth has almost tripled from $33.8 trillion in 2000 to $90.5 trillion at the end of 2019. China, in particular has grown dramatically from a small economy representing less than 1% of global GDP, into a major economic power rivaling the United States and European Union at 17%. It is expected to surpass both in the coming decade.

Chart 1

In 2000 there were about 350 million people online, representing about 6% of the world’s 5.9 billion people. By the end of last year, the number of people online had grown ten-fold to 3.7 billion people, representing over 50% of the world’s current population of 7.5 billion people. China now accounts for more than 21% all internet users. The U.S. accounts for 8%.

In 1999, the top 10 companies in the world as measured by market capitalization were typically well-established firms and weighted towards major oil companies or companies involved with building out the internet.

Chart 2

Fast forward 20 years and some of these companies no longer exist or are ghosts of their former selves. By contrast, half of today’s top ten companies had only recently been founded in 1999 or didn’t exist yet. Moreover, two of the top ten, and seven of the top thirty companies in the world now are Chinese. It is likely that in ten and twenty years, the list of top companies will change again and that more of them will be from China and elsewhere in the developing world.

While investors may obsess from quarter to quarter on whether a company beats or misses its earnings forecast, what really matters is whether the company is gaining or losing competitive advantage against a backdrop of rapid technological and social change. In a digital economy, companies can now be created and scale to very large sizes very quickly, and well-established companies can lose their competitive advantage and disappear just as fast.

Consider that a mere twenty years ago, there were no smartphones, Netflix sent DVDs by US mail, cloud computing did not exist as a business, and electric cars had been abandoned by General Motors as unviable. There was no internet of things, autonomous vehicles or virtual reality. Machine learning and artificial intelligence were nascent technologies in research labs rather than features in consumer products. Siri and Alexa were just girl’s names, and social media was in its infancy. There was no Uber and Lyft, Airbnb, or “sharing” economy. The human genome had not been fully sequenced.

Outside the world of technology, fracking and horizontal drilling technology has allowed the U.S. to become one of the world’s leading energy exporters and much less reliant on foreign imports than it was 10 or 20 years ago. The world has also seen exponential growth in the use of alternative energy sources like solar and wind for power generation as they become cost competitive with fossil fuels.

On a less rosy note, the U.S. as well as the rest of the world has seen an explosion in debt combined with a secular decline in interest rates. In the U.S., total credit market debt – encompassing all private and public sector debt – has tripled from $25 trillion to almost $75 trillion, while public debt has grown from $5.7 trillion in 2000 to over $22 trillion and now represents more than 100% of U.S. Gross Domestic Product. Over this same period, the yield on a U.S. 10-year government bond has declined from over 6% to under 2%. In many parts of the developed world, interest rates are actually negative, causing capital to gravitate towards higher risk assets in search of higher returns.

Chart 3

Finally, from a geopolitical standpoint, the world has changed a lot over the past two decades from a unipolar world with the United States acting as the clear economic, military and moral leader, to a multi-polar world with multiple nations acting in their own best interests. In particular, we have seen the rise of China as a competing economic and military power and Russia as a global troublemaker. While the U.S. is receding from its involvement and commitments to the rest of the world, China, Russia and other nations and actors have been stepping in to fill the void. China in particular has been making major investments throughout Asia, Africa and South America to secure raw materials, create markets for its exports, and project military and economic influence. Meanwhile, in Europe, Britain just reelected Boris Johnson based on his promise to exit from the European Union. The original promise of the European Union and common market is now greatly diminished. It remains to be seen if other members will try to follow the British example. Within the United States and elsewhere in the world we have seen a disturbing trend toward increasing political divisiveness, nationalism and populism.

With all the attention focused on the major world powers, a more hopeful story that gets missed is that overall standards of living around the world are improving. The majority of the world’s population lives outside of the Western world and is experiencing the greatest growth in population as well as improvement in living standards. Although income and wealth inequality continues to grow, there are fewer people in the world living in poverty.

Climate change adds another large dose of uncertainty as we look forward. The growing frequency and magnitude of extreme weather events in recent years, including storms, floods, droughts and fires is alarming. It presents major new challenges to affected populations and industries.

And so, while it is tempting to think of each new year as an incremental and linear progression of the one before, that’s not really the case. Major changes are in the works under the surface and the next twenty years will likely involve even more significant growth and transformation.

Consequently, it is important to invest with a forward-looking view of the world; identifying major trends and areas of innovation, disruption, challenge and opportunity and investing accordingly.

2019 Review

2019 was a very strong year for global financial markets across almost all markets and asset classes, a nice contrast to 2018 when almost everything suffered a loss.

The U.S. stock market continued its dominance relative to the rest of the world with the bellwether S&P 500 index producing a whopping 31.5% return. International stocks including emerging markets also performed well, although when combined with their dismal performance in 2018, remain far behind the U.S. in performance on a multi-year basis. Gold also regained some of its lost luster with a respectable 17% return for the year. Bonds around the world also had a banner year, benefitting from a significant decline in interest rates around the globe during the year. This decline in interest rates drove much of the price appreciation across asset classes.

Chart 4

Looking forward

Our investment outlook is structured around the major trends and ideas discussed above and shaped by current conditions. Some of the key guiding ideas that drive our current portfolio positioning include:

Technological Innovation: The scope and pace of technological innovation, disruption and progress is only increasing. We want to have investments oriented towards all areas of change and innovation around the globe with an approach of owning the racetrack rather than picking specific horses. We want to own companies that are creating change rather than those who are being disrupted by it. These investments will tend to have higher valuation levels and higher levels of volatility, but we see their ebbs and flows as cyclical relative to a secularly rising growth rate.

The Developing World Consumer: The “developing” world is maturing rapidly. It is already larger than the developed world and growing faster. While still quaintly referred to as “Emerging Markets,” China and India together account for 30% of the world’s population and have a combined GDP that already rivals the United States or Europe. In the next decade China should easily surpass the U.S. and become the largest economy and consumer market in the world. At the same time, Chinese equity markets are also growing rapidly and are expected to represent over 20% of global equity market capitalization by 2030. As this happens, an increasing share of global capital should flow into China as well as other emerging markets.

Healthcare Innovation: The populations of the developed world are getting older and living longer, creating rising demand for healthcare services. At the same time the healthcare system in the United States and in many other parts of the world is inefficient, expensive and in need of radical change. There is a growing demand for more effective new technologies, treatments and services. We want to have investments focused on these areas of innovation including life-sciences and medical technology.

Mounting government deficits and debt: Now that governments around the world seem to have let the deficit genie out of the bottle, it is hard to see them wanting to put it back. Promises of fiscal propriety, higher taxes and fewer social services tend to lose elections.

With the prospect of rising public debt levels around the globe, governments running higher and higher deficits to keep voters happy and central banks printing money, we would expect the long-term trend for interest rates to be higher. After all, by definition, by printing money and running higher and higher deficits, countries are debasing the value and creditworthiness of their currency and investors should ultimately want a higher return to compensate for this. So far, this has not been the case and may not be for years to come.

What we do know is that the return prospects for government bonds are low and unattractive relative to other financial assets such as stocks and real estate that have intrinsic value and can increase that value over time. They can play a useful role in a portfolio as a safe harbor in a storm, but are not compelling as a long-term way to preserve wealth.

Against the backdrop of these longer-term views we think that economic growth around the world is likely to continue into 2020 and should improve in the wake of the recently announced Phase I trade deal with China. Although the trade deal doesn’t appear to resolve any major issues, it does remove punitive tariffs as well as a large cloud of uncertainty that has been hanging over the global economy.

The trade war impacted the rest of the world more than it did the United States, which is much less dependent of foreign trade. We would therefore expect a thawing in trade relations to disproportionately benefit countries and markets outside the U.S.

In addition to the trade truce, we expect Great Britain to finally negotiate a successful “Brexit” from the European Union, removing another overhang over the global economy.

It is also an election year in the U.S. and the markets may be volatile as we approach the election depending on who the Democrats nominate as their candidate and President Trump’s probabilities of getting reelected. At the moment his chances for reelection are closely linked to the health of the economy and level of the stock market, the only two areas where he gets good marks from voters. It is therefore reasonable to think that he will do whatever he can to stoke the economy and markets into the election, and avoid getting involved in an escalating military conflict with Iran. Of course, anything is possible and we continue to counsel clients to avoid mixing politics and investing. It is too hard, and the market tends to do the opposite of what most people expect.

After significant appreciation in 2019, valuation levels for stocks are elevated, especially in the United States. Markets are therefore more vulnerable to negative surprises and disappointments which, like the current conflict with Iran, can come out of nowhere.

On a relative basis, Europe and Emerging markets look more attractive than the United States, especially if we see a pickup in global economic growth. As a result, we have trimmed and reallocated some of our U.S. stock exposure towards International and Emerging Markets.

We expect stocks to rise in 2020 but do not expect a repeat of 2019, which was largely driven by a sharp decline in interest rates and an increase in overall valuation levels. Interest rates will likely remain range bound or may even rise if we see a whiff of inflation.

Unless we enter a bubbly “blow-off” rally as we did in 1999 where animal spirits took over and investors bid up stocks to ridiculous levels, appreciation in stocks will have to be driven by fundamental improvements in sales and earnings. Although our near-term expectations are more guarded, for long-term investors we still think stocks and real estate look more compelling than bonds.

As always, we welcome your comments, questions and referrals.

Jurika, Mills & Keifer,
January, 2020

Important Disclosures

Opinions expressed are those of Jurika, Mills & Keifer, LLC, and are subject to change.

Investments in securities involve the risk of loss. There can be no assurance that investment strategies referenced will be successful, or that investment objectives will be achieved. The net performance represents performance figures net of all fees including management, performance fees, transaction costs and commissions. Past performance is no guarantee of future returns, which may vary. Please note that one cannot invest directly in an index.

This communication is neither an offer to sell nor the solicitation of an offer to buy a security or advisory services, which can only be made by the appropriate offering document.