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Commentary & Insights


An Appetizing Year - January 2020

01 January 2020
photo of a bowl of stew
WCF Staff

“He didn’t want me to reject it out of hand, which I might have done, because it was a crazy idea. But when I tasted it, I was sold.”
- Ray Kroc, on his introduction to the Egg McMuffin. (1)

The Egg McMuffin was invented right here in Santa Barbara by Herb Peterson, a McDonalds franchisee, back in 1972. History is replete with examples of significant food inventions including Hot Dogs (Nathan’s Famous on Coney Island; 1916), Cobb Salad (The Brown Derby in Los Angeles; 1926), Bananas Foster (Brennan’s in New Orleans; 1951) and California Rolls (Tokyo Kaikan in Los Angeles; 1970).

To this illustrious list we would like to nominate the Stew, made on Wall St. in 2019. Technically, stew is a type of food consisting of meat or fish and vegetables, cooked slowly in a small amount of liquid. It’s a great metaphor for how we see the stock market, with its performance a mix of economic growth and earnings (protein and veggies) and interest rates (the liquids).

How Good was the Stew?

Well, the S&P 500 rose by more than 25% for the year. It wasn’t the only variation that stood out. Small stocks were up by more than 20%; Japanese stocks, Chinese stocks, and even gold were all up more than 15% for the year.

Was it the Meat?

One would be hard pressed to make the argument that the strong equity market performance was driven by the economy or earnings. GDP, the measure of all economic activity, expanded by approximately 2% in each of the past two quarters, a yawner by historical standards. (2)

Corporate earnings were flat in 2019, with virtually no growth. (3)

Or Perhaps the Cooking Method?

The 2019 vintage, as it turns out, wasn’t so much the meat, the fish or the vegetables. Instead, these stews owe their success to their slow braising in liquid.

Slow: Pulling out of the severe recession in 2008 required Herculean efforts on behalf of the monetary authorities around the globe. Academic economists believed that the price of the recovery would be a sustained period of sub-par economic growth. (4) We have highlighted, in the chart below, the muted nature of the economy since 2008. (5)

graph of real gross domestic product

No economic overheating occurred during this period of economic simmer, featuring slow but steady growth. Therefore, inflation has remained mild, allowing the cycle to continue uninterrupted, tantamount to using a crockpot.

Why the low inflation? Consider the core costs of running any business: labor, capital and energy. The chart below shows that real wages have gone up by less than 1% per year since 2009. (6)

graph of median usual weekly real earnings

Both a glut of skilled labor (think globalization) and industrial automation (think robots) serve to keep a lid on wage growth. Monetary policy drives the cost of capital and interest rates remain near historical lows. Finally, it requires energy to both manufacture and transport goods. Relative to the $140 peak price reached in the summer of 2008, today’s $65 per barrel of oil represents a bargain. (7) Steady growth absent inflation allows the Fed to continue with easy money policies. Thus, we have now gone 11 years without a recession.

Liquid(ity): Recessionary concerns reemerged in the fall of 2018 when the yield curve inverted, and the heat turned up on the trade war. The S&P 500 dropped nearly 20% (the definition of a bear market) in the 4th quarter of 2018. Three consecutive interest rate cuts in 2019, engineered by the Federal Reserve, created the perfect simmer – more liquids. The 10-Year Treasury yield, as seen in the graph below, dropped nearly 50% from the peak of 2.80% to the trough of 1.55% during the year. (8)

10 year treasury rate

How is it possible that subdued economic growth, along with stalled earnings in 2019, produced such a sweetened year for the equity markets? The S&P 500 started 2019 at 2507, or 15 times the 2018 earnings of about $162. Mathematics suggests, with the closing price of 3217 on those same frozen earnings that the price to earnings ratio spiked from 15 to almost 20. A delicious year; built on optimism and liquidity instead of meat and veggies.

2020 Stew

The new year has two things cooking, so to speak. First, the broth. Plenty of premium liquid stemming from persistently low interest rates. Second, momentum; what tasted good last, according to Wall St., tends to look appetizing in the following year. The concept, commonly known as momentum, has some academic support, though it tends to result in exaggerated moves in both up and down markets – like the impact of MSG on food flavoring.

With stocks already trading at a high valuation, the market might echo an old Wendy’s commercial and ask, “Where’s the beef?” Analysts currently look for earnings of $178 on the S&P 500. (9) Coming off the $162 earnings figure for each of the past two years, that would represent about 10% growth. However, that $178 average comes with considerable range. If the economy produces enough yeast to levitate earnings, stocks could have another decent year.

However, that requires the avoidance of:


  • Geopolitical disturbances such as those brewing in Iran and North Korea.
  • Tensions with China. Trade war tariffs have slowed both the U.S. and Chinese economies, along with those of many trading partners. Trade wars, the GM strike, and the shutdown of the Boeing 737 Max have combined to create a serious drag on the manufacturing sector. In fact, the ISM manufacturing index dropped in December for the fifth consecutive month, to levels last reached in 2009. (10)
  • Further diminution of free trade around the globe that puts a natural brake on economic efficiency and growth.
  • A spike in inflation. The Fed has a clearly articulated goal of inflation reaching 2% and would be challenged to continue easy money policies should inflation breach that level.
  • Any election surprise with a signifi cant divergence in potential economic policies.
  • A loss of optimism. Investors must remain upbeat to maintain the high multiple being paid on earnings.

Not an easy recipe, but doable.

Foreign stocks, as measured by the MS EAFE Index, trade at approximately 16 times earnings compared to 20 on the S&P 500. EAFE currently provides a dividend yield of 3.23%, or 65% better than the 1.95% from the S&P 500. (11) The gap between the U.S. and the rest of the world, as seen in the graph below, is butting up against its 18-year high. (12)

graph of Forward P/E: US Minus World EX-US MSCI

One could argue that all the growth in the world emanates from Silicon Valley, but we like the attractive valuation, the higher yield, and the potential diversification afforded by owning foreign securities – a bit of spice.

2019 brought a fine stew based on slow cooking and ample liquids. That tasty dish might be tough to replicate in 2020, but we can lean on the sage advice of one of the real pros. Wolfgang Puck once said, “Cooking is like painting or writing a song. Just as there are only so many notes or colors, there are only so many flavors – it’s how you combine them that sets you apart.” (13)

We couldn’t agree more.


  1. Grinding It Out, The autobiography of Ray Kroc. 1977
  2. Bureau of Economic Analysis; Report issued 12/20/2019
  3. Yardeni Research Inc.; December 16, 2019. Earnings for the S & P 500 were $161.93 in 2018 and though not finalized for 2019, are estimated at $162.06
  4. This Time is Different; Carmen Reinhart and Kenneth Rogoff; 2009
  5. Federal Reserve Economic Data; FRED.StLouisFed.Org
  6. Federal Reserve Economic Data; FRED.StLouisFed.Org
  7. Federal Reserve Economic Data; FRED.StLouisFed.Org
  8. Graph Ten-Year Treasury Yields through 2019;
  9. “Investors Upbeat as Stock Gains Outpace Profi ts”. Wall St. Journal; 12/26/2019
  11. December 2019 Manufacturing ISM® Report On Business, Institute for Supply Management; January 3, 2020
  12. Yardeni Research Inc.; December 16, 2019
  13. Wolfgang Puck interview with Perry Garfinkel. Huffington Post; February 3, 2012