The turning of the calendar shouldn’t, in theory, change a person’s outlook or investment plans. But we know, in practice, that this isn’t the case.
Investors often use the new year as an opportunity to reset and reevaluate expectations, while adjusting their asset allocations for the year ahead. Investors also generally tend to pay too much attention to year-to-date return figures. Since these get reset on Jan. 1, sectors with monster 2019 returns, such as semiconductors, clean energy and homebuilders, can, for better or worse, suddenly look less attractive.
Last year was unusual in that you could make money just about anywhere you invested, in both stocks and bonds. The S&P 500 finished the year with a gain of 29% while long-maturity Treasury bonds posted a total return of around 14%. The last time both stocks and Treasuries posted double-digit returns in the same year was 2014. To find a year when the S&P 500 and Treasuries did this well, you’d have to go all the way back to 1998. Last year wasn’t necessarily a year without precedent, but 2019 was rare to say the least.
The strong returns for both equities and fixed income point to the divisiveness of the current economic landscape and how investors are willing to position their portfolios. S&P 500 earnings growth was virtually flat year over year (the boost from the corporate tax cuts in 2018 is at least partially to blame for that) but multiple cuts to the Fed funds rate and hundreds of billions of dollars in Treasury purchases by the Federal Reserve have certainly been supporting the latest bull run.
Slowing global economic growth, rising corporate debt loads and the uncertainty surrounding a never-ending U.S.-China trade war present significant risks to the financial markets in 2020, but I’m not necessarily bearish. A potential recession doesn’t appear likely until at least 2021 and the Federal Reserve with its $400 billion (and counting) of “not QE” seem ready to support asset prices at all costs at least through November’s presidential election. If the Fed is indeed able to engineer a soft economic landing and manage to keep the U.S. economy out of recession, there’s no reason to think the S&P 500 couldn’t produce another year of 10%+ gains in 2020. But the macro risks could make a correction or even a bear market just as likely at some point during the year.
That’s why many of my top picks for 2020 are of the defensive variety. In 2019, investors focused primarily on large-caps, growth and tech - three themes that have played out well in years past and delivered above-average performance again. This year will likely be more of a stock-picker’s market in which investors will need to be a bit more selective in order to generate outsized gains. I anticipate a few broad macro themes to play out in 2020 and many of my ETF picks will be reflective of those expectations.
There were a couple of funds that I considered that didn’t quite make the cut.
The ETFMG Alternative Harvest ETF (MJ) - Get Report, otherwise known as the Marijuana ETF, has been on my radar for some time (in fact, I posted a video recently detailing its investment case). MJ has been one of the worst performing funds of 2019 as the pot bubble burst and future growth expectations were curbed. Marijuana is still a rapidly growing industry and I feel much of the excess has finally been worked off of share prices, but many of these companies are facing a serious liquidity crisis that could bankrupt several names this year. It’s an intriguing idea but one I just can’t get fully behind as a top performer yet.
I also considered the Global X Uranium ETF (URA) - Get Report. The uranium industry has been in steady decline ever since the Fukushima disaster and decelerated further when President Trump declined to support quotas that would have required at least 25% of the U.S. uranium market to be sourced domestically. A recent report, however, suggests that the White House is urging Trump to reconsider and supports measures to develop a domestic uranium stockpile citing national security concerns. If it happens, it will mark a sharp increase in demand for U.S. uranium but there’s still too much uncertainty here.
With that being said, here are my top 10 ETF picks for 2020.
For several years, the financial sector has struggled with profitability as the flat yield curve has put a lot of pressure on operating margins. In response, banks have been instituting cost-cutting measures, including job cuts, and focusing on other business units, such as investment banking and trading, to help make up the difference.
But now, the interest rate environment is starting to normalize once again. The 10Y-3M Treasury yield spread, which had dipped to as low as -0.52% at the end of August, is back to 0.31%. The 1-year T-bill still yields less than the three-month, but everything else is back where it should be.
We can thank solid, if not strong, GDP growth, low unemployment and a Fed willing to support the markets for improving investor optimism and raising expectations for stronger loan growth going forward.
With the Fed willing to let the inflation rate move above its 2% target in order to “make up” for past low inflation, the long-end of the yield curve could be heading higher yet, making banks even more attractive.
We’re already starting to see this story play out as banks have outperformed the S&P 500 by about 6% over the past three to four months. The yield curve will be key. If it remains normalized and the 10Y-3M spread continues to expand, financials could be the biggest sector outperformer of 2020.
For additional commentary and video content on the SPDR S&P Bank ETF as one of my top picks for 2020, click here.
Commodities are at 50-year lows relative to equities. Of course, you could have said that at just about any point over the past five years and the commodities-to-equities ratio just kept dropping.
So what makes 2020 the year that things might finally start turning around?
The key could be inflation and the slowing global economy, two factors which really haven’t been a big concern up until 2019. Natural gas is still about 75% off its 2014 high. Crude oil is nearly 50% off of its 2011 high. Silver is down 60%.
While the Fed’s preferred inflation measure, the personal consumption expenditure (PCE) price index, is up just 1.3% year over year, the U.S. Consumer Price Index and core CPI rates are both over 2%. If inflation keeps ticking up (and personal income and spending numbers suggest it can), expect commodities prices to tick up as well. West Texas Intermediate crude is at $62 per barrel with OPEC production cuts extended into 2020. The foundation is in place for the rise to continue.
As the graphic above indicates, commodities prices rise rapidly as bubbles begin deflating. I think the Fed is determined to make sure that doesn’t happen, especially heading into an election year. But this group is certainly long overdue for an extended period of outperformance relative to stocks.
For additional commentary and video content on the Invesco DB Commodity Tracking Index ETF as one of my top picks for 2020, click here.
Time to beat the inflation drum yet again!
TIPS returned around 8% to 9% in 2019, but it had nothing to do with inflation. It was the fact that they were Treasuries first and foremost that drove those gains. TIPS trailed the broader Treasury bond market for much of the year until the fourth quarter when inflation risk started getting priced into the market.
While the Fed would have you believe that there's no inflation, the core inflation rate is 2.3%, above the Fed's 2% target, and it's been there for almost two years.
I like TIPS in 2020 because they potentially offer the best of both worlds. If the economy shows signs of slowing, investors will likely begin taking risk off the table, which would be bullish for Treasuries. In that case, TIPS participate in the risk-off rally.
If the economy shows signs of recovery but inflation starts rising, TIPS, whose prices are regularly adjusted according to the latest inflation rate, likely outperform the broader Treasury market.
If you’re looking to position your portfolio defensively in 2020, TIPS, in my opinion, represent the best option from the Treasury market.
For additional commentary and video content on the iShares TIPS Bond ETF as one of my top picks for 2020, click here.
There are any number of ways to make the bull case for gold and gold miners right now.
- An economic slowdown will result in a rush to safe-haven assets.
- Gold has strongly outperformed stocks following yield curve inversions.
- Miners are still undervalued relative to the price of gold.
- $400 billion of Fed money printing can’t go on forever without consequence.
My original call for gold earlier in December was that it would threaten to move back to the $1,350 level following a strong third-quarter GDP reading and a better-than-expected November jobs report. The logic was that those numbers would drive investors toward risk assets and away from Treasuries and gold. Once it tested that level, it would make a run toward $1,700.
But the pullback in gold didn’t happen and now it looks like it’s making its move toward $1,700 now. Why gold miners over physical gold? It’s really a matter of risk exposure.
Gold miners tend to be around three times as volatile as the price of gold, which you can see pretty clearly in the chart above. If gold gets to the $1,700 level, gold miners should be able to post returns in the 20% to 30% range.
For additional commentary and video content on the VanEck Vectors Gold Miners ETF as one of my top picks for 2020, click here.
If you believe in gold for 2020, there’s no reason you shouldn’t appreciate silver even more. It doesn’t get nearly the attention that gold does among market-watchers, but silver offers a deep value opportunity in addition to the precious metals upside.
After moving in lock-step with gold earlier this decade, gold prices started to move up while silver mostly moved sideways, a trend that has been in place for the past four years. Not only do I see precious metals making a significant move up in 2020, I think silver is finally going to close the gap to gold as well.
I made the case for silver not long ago and put a $20/ounce short-term price target on it. I believe that $25 is very much in play by the end of 2020, although that should probably be considered a best case scenario.
For additional commentary and video content on the iShares Silver Trust ETF as one of my top picks for 2020, click here.
At some point, investors are going to need to move away from their overwhelming bias toward U.S. large-caps. If they finally do, they’ll find an environment primed for outperformance by international equities, emerging markets in particular.
The case here is pretty simple - emerging markets offer better growth prospects, better dividend yields, cheaper valuations and they’re starting to get the benefit of a weakening dollar at their back.
While emerging markets are expected to grow around 4% annually, compared with 1% growth expectations for developed markets, it’s the valuation gap that makes a more compelling argument. A chart I like to use often shows how emerging markets forward five-year returns relative to the S&P 500 are greater as the P/E discount deepens.
This chart is outdated by a couple years but the statement it makes is clear. The bigger the discount, the greater the EM equity outperformance. The current emerging markets P/E ratio is about 40% below that of the S&P 500. If history holds, emerging markets stand to outperform U.S. equities by about 10% to 15% annually over the next several years.
And the wheels might already be in motion. After trending higher for more than a year, the dollar has broken below long-term support and sits about 2.5% below its September high.
Given the backdrop of low growth and the Fed printing billions of dollars in new money every week, the dollar index looks ready to pull back to 95 in the short-term and 92 by the second half of 2020.
All of the pieces are in place for a sustained period of potentially significant outperformance for emerging markets. Not only is this a good bet for 2020, it looks like a strong buy-and-hold candidate for the next five years. EEMS offers a higher risk, higher return opportunity since it’s targeting small-caps. If you want something a bit less aggressive, stick with the iShares Core MSCI Emerging Markets ETF (IEMG) - Get Report or the WisdomTree Emerging Markets High Dividend ETF (DEM) - Get Report.
For additional commentary and video content on the iShares MSCI Emerging Markets Small Cap ETF as one of my top picks for 2020, click here.
Developed markets should benefit from the same fundamental backdrop as emerging markets. Given the economic troubles in places, such as Germany, France and Italy being more selective might be a better strategy than owning a diversified basket.
The Japanese economy looks a lot like that of the United States. Business investment and import/export activity have been weak, but consumer spending has remained strong. The Japanese central bank has held its benchmark rate steady at -0.1% for some time, but gave strong indications earlier last quarter that it’s prepared to both lower rates further and add liquidity to the economy in order to stimulate growth. That type of central bank backing has done wonders for equity prices here in the U.S. and could deliver a repeat performance in Japan.
The major factor which could affect the performance of Japanese stocks in 2020 is the recent increase to the national sales tax from 8% to 10%.
It appears that shoppers raced out to stores ahead of the October tax hike. Month-over-month gains in retail sales looked strong in August and September before falling off a cliff in October, as expected. The encouraging sign is that sales rebounded again in November offering hope that consumers haven’t significantly changed their spending habits.
Stocks weren’t terribly volatile in the second half of 2019 suggesting that the downside from the sales tax hike is already full baked into prices. If that’s the case, the dovish central bank and healthy consumer should lead to further gains.
For additional commentary and video content on the iShares MSCI Japan ETF as one of my top picks for 2020, click here.
In case you haven’t noticed, I’m taking a decidedly defensive approach to 2020. By no means am I suggesting that investors should be selling off their equity positions in the new year, but I think principal protection and preservation should be a theme for most investors.
QDEF is one of my favorite ETFs. The fund’s index scours the universe of dividend-paying stocks by looking at factors such as profitability, cash flow and management efficiency, to assign an overall dividend quality score to each. Those with the lowest scores are eliminated and all remaining qualifying stocks are then optimized into a high quality, high yield portfolio that has a beta between 0.5 and 1.0.
The fund tilts very heavily toward large-caps, but includes many of the most durable, financially healthy companies in the world.
The final product ends up displaying a lot of the characteristics of a low volatility, value-oriented portfolio - ideal if the economy and the markets turn sideways - while the high yield is an added bonus. The yield premium on QDEF has historically been in the 0.75-1.00% range, which is where it is right now - 2.65% for QDEF vs. 1.68% for the S&P 500.
QDEF is a good play on equities if you want to maintain U.S. large-cap exposure, still the preferred asset class of many investors, while providing a downside buffer.
For additional commentary and video content on the FlexShares Quality Dividend Defensive ETF as one of my top picks for 2020, click here.
For those of you waiting for a growth pick for 2020, we’ve finally arrived at the section for you!
It’s not a particularly bold prediction to choose the ETF that’s been nearly the No. 1 performing non-leveraged fund over the past decade, but there’s still a pretty compelling bull case to make.
Biotech has enjoyed an extended period of positive drug development results and is enjoying something of a resurgence in M&A activity. Despite the massive rally in biotechs in the fourth quarter, the sector still trades at a 15% discount to the S&P 500, a bit of an anomaly considering that biotech earnings are expected to grow at double the rate of the S&P 500 over the next three to five years.
Another underappreciated benefit of biotech is that it has a low correlation to the broader market. Take a look at how the sector performed during the financial crisis.
Biotechs outperformed large-caps by nearly 35% over the three-year period around the financial crisis. Moreover, the S&P 500 dropped around 55% from peak to valley. Biotechs? They dropped just 37%. That’s not to suggest that you should add biotechs to your portfolio as a defensive play in case of another crisis, but it does demonstrate that the sector has some real diversification benefits.
Why did I choose XBI over the more popular iShares Nasdaq Biotechnology ETF (IBB) - Get Report? Quite simply, XBI is equal-weighted whereas IBB is market cap-weighted. IBB is very top-heavy in the industry’s biggest names, such as Gilead Sciences (GILD) - Get Report, Biogen (BIIB) - Get Report and Amgen (AMGN) - Get Report, exposing it to added risk if any one of those names struggles. XBI’s limited exposure to any single name helps reduce overall risk.
For additional commentary and video content on the SPDR S&P Biotech ETF as one of my top picks for 2020, click here.
Innovator S&P 500 Power Buffer ETF PDEC
Looking for S&P 500 returns with a built-in hedge against a percentage of the index’s losses?
Innovator’s series of defined outcome ETFs have been something of a revelation for investors looking for the best of both worlds. The high level explanation for how these funds work is that they protect against a certain percentage of S&P 500 losses while offering S&P 500 returns up to a certain cap. Innovator offers several different products with varying levels of return caps and buffers depending on what kind of protection you’re looking for.
The tradeoff with these products is that you’re sacrificing possible returns in exchange for a downside buffer. In the case of PDEC, if you invest on the first day of the outcome period, you’re protected against the first 15% of losses in the S&P 500 but your gains are capped at 8.5% for the year.
These products are a bit technical to get a full understanding of how they work and I don’t want to get too deep into the weeds here. But if you want to maintain exposure to equities in case prices keep rising while protecting yourself against a sharp sudden downturn, these buffer ETFs are worth a look (and to be clear, Innovator offers dozens of these funds with different caps and buffers).
An interesting strategy would be to roll over your investment into a new buffer ETF every month. That would essentially reset your downside buffer every month while maintaining most of the equity upside. It could, in theory, eliminate much of the downside risk in your portfolio indefinitely.
For additional commentary and video content on the Innovator S&P 500 Power Buffer ETF as one of my top picks for 2020, click here.