Dear Friend:

In the face of many challenges, 2019 turned out to be a surprisingly rewarding year for investors. We were cautiously optimistic about the economy going into 2019 and maintained that opinion throughout the whole year. We acted when we had a firm conviction of the results. There were questions regarding the market valuation and geopolitical unrest, but we kept reminding everyone of the long-term prospects and investment disciplines. We stayed focused on individual companies and securities and ignored the noise in the markets. We believe these were the right strategies for a year like 2019.

Review of 2019

The equity markets’ returns for 2019 can be broken down in earning per share growth, multiple expansion, dividend yield, and currency effects for non-US markets.  Chart 1 illustrates the performance drivers.

Chart 1 – Breakdown of returns

Source: J.P. Morgan Asset Management

Multiples expansion (grey bar) was a significant factor for markets’ performance in 2019, and it happens when investors have confidence in future earnings.  They expect the Earning of the P/E ratio to become a more significant number – so to bid up the Price assumes the E will catch up eventually.  It was a different story in 2018 when earnings growth (dark blue bar) was a significant positive driver but was overtaken by negative sentiment during the last quarter because of the trade wars.

As communicated in our third quarter newsletter, we noticed the global economy slowing down, and U.S. corporations’ profitability plateauing, as shown in Chart 2. However, these fundamental concerns did not discourage investors.  We believe the reasons listed below kept the investors’ confidence intact, and hence, the multiples continued to expand.

• Investors still hold a large amount of cash and wait for opportunities to invest.
• The rhetoric of trade wars calmed towards the end of the year.
• Recessions in the developed economies did not happen because of stable job growth and healthy consumption growth, especially in the U.S.
• The meltdown in China did not happen. China is no longer just an export-oriented economy. Roughly 60% of its economy comes from consumption. Based on the recent data, exports to the U.S. is only 3% of the Chinese annual GDP.
• Lower interest rates and healthy job markets did not trigger high inflation.

Chart 2 – Sources of earning per share growth

Source: Bloomberg, S&P Dow Jones Indices

Outlook for 2020 and beyond

The conflict between the U.S. and China remains one of the most important global issues in 2020. It has extended beyond the trade issues and could be a longer-term battle. Resolution seems to hinge on the political dynamics of both countries. However, for both countries’ statesmen, a stable economy in 2020 is crucial in many aspects. For the U.S. President, a steady economy is critical in an election year while Chinese leadership needs to sustain a slower but higher-quality growth. We believe smaller deals like the one negotiated in December last year are feasible, and the willingness to do so is a good signal for the markets.

We think other geopolitical events, i.e., the anti-government protests in Hong Kong, South America, Europe, the elevated war risk in the Middle East, and the Brexit process could also bring volatility to the market in 2020. We believe most of these events are a result of governments’ neglect of social problems brought by globalization, immigration, and income distribution. These issues become worsened by the polarization of political opinions and the prioritization of public sentiment over experts’ knowledge.

After the World Trade Organization was established on January 1, 1995, corporate profitability in the developed countries rose as did inequality. Real wage growth in the developed countries has languished, and the pain caused by the offshoring was relieved by low inflation, labor union protections, and government subsidies. For example, the average hourly wage in the U.S. was $23.83 in November 2019 which has grown 2.4% annually for the past decade; however, the real growth rate was only 0.52% once adjusted for core inflation.

Another concern is the valuation of the market – “Is the market too expensive? Should I get out?” was the most asked question.  In the short-term, we believe all the reasons supporting the market in 2019 will continue in 2020. Our confidence comes from the low-interest-rate environment, healthy consumers, and the stable cash flow generation by corporations.

Due to trade conflicts, many U.S. companies chose to postpone decisions on capital expenditures before they fully understand the impact on global supply chains. Those with steady cash flow decided to return capital to shareholders by raising dividends or share repurchases. Chart 3 shows the U.S. companies’ hesitation on investment and their willingness to reward shareholders. We believe the share buyback activities will continue, capital investment and M&A activities will return if interest rates stay low, and the U.S. economy remains at a similar pace.

Chart 3 – U.S. companies’ capital deployment

Source: Federal Reserve Bank of St. Louis, IMAA Analysis, S&P Dow Indices

Central banks’ easing is another reason why we believe the global equity markets could have support in 2020. Chart 4 shows the current monetary policies in all major economies. We don’t think the central banks will change the trajectory of interest rates in 2020 without a trade war conclusion and the proof of sustained inflation.

Chart 4 – Global Monetary Policies

Source: Refinitiv Datastream

Beyond 2020, we remain confident about the long-term themes we discussed in the past. First is the growing middle class in emerging markets. We cannot emphasize enough how important this theme is to the global economy (see Chart 5). It is also the primary growth driver for many of our companies. We anticipate more opportunities to surface in the coming years. Global brands will continue their success in both developed and emerging markets. Domestic leaders in consumer, tourism, financial, and healthcare industries are the potential winners in 2020 and beyond. We are also interested in companies that help to provide clean water, air, and energy as these are the next quests from the growing middle class for a better quality of life.

Chart 5 – Emerging Economies

Source: J.P. Morgan Asset Management, Brookings Institute

Advances in the technology, healthcare, and communications industries are giving us hope that humans have not exhausted the potential for productivity improvement.  We expect to hear exciting news in autonomous driving, the 5G network, successful clinical trials of immunology drugs, and expanding applications of robotic surgeries.

Over the years, we have been deploying the same philosophy and disciplines in investments. Our focus has always been on the individual company’s story and the industry dynamics. We monitor the macro environment but never allow the market sentiment to drive our decisions. We do not believe the markets are always rational and fully efficient in the short term, so we maintain flexibility in the portfolios for possible actions. We are not market timers but try to buy low and sell high. The combination of these strategies has worked for long-term investors, and we believe it will continue to work in 2020.

Thank you for your business and friendship in 2019, and we wish you a healthy and prosperous 2020!

Sincerely yours,

Research Team