As we enter the new year, the Cornerstone team is continually examining equity and fixed income market data for what to expect in the future. Currently, we see opportunity for continued growth in 2020. Here’s why.
Productivity and Profits
Looking forward to 2020 and a hopeful continuation of this historic bull run, we’re focusing on two key things – profit and productivity.
The red line in the below chart indicates the 52-week forward profit margin for the S&P 500 has been around 12 percent all year. Given all the negative headline news we see regularly about tariffs and rising labor costs, that’s quite impressive.
This profit margin consistency indicates that productivity growth is offsetting rising labor costs. In the next chart, we see productivity bottomed out in 2015 around 0.5 percent. But in the first quarter of 2019, it rose to 1.3 percent. It’s pedaled back to 1 percent in the latest data, but the trend since 2015 clearly is positive.
We see a long-term trend of productivity increases due to cloud computing and 5G technology. Productivity gains translate to increased profits, which lead to higher stock prices because underlying fundamentals rely on earnings and profits.
We’re entering the next big wave of global technology innovation in several areas – mobile, cloud, artificial intelligence, big data, virtual reality, robotics, 3D additive manufacturing, and 5G. Those all can transform health care, transportation, energy, education, manufacturing, agriculture, retail, and many more sectors.
Simply put, as workers become more productive, companies become more profitable. Of course, there are possible headwinds that could derail progress – trade, politics, interest rates, and more. But if the bull run continues, we think it will be because of productivity and profits.
High Yields in a Low-Rate Environment
Fixed-income investors are finding it tougher to achieve high yields in the current low-rate environment. Here are two out-of-the-box ideas for higher yields in 2020 and beyond.
Convertible Bonds
This is a niche sector, to be sure. Convertible bonds allow investors to buy bonds and can convert them to stock if the price takes off. You can invest in them via closed-end funds, open-ended funds, and ETFs (we don’t recommend individual convertible bonds for the retail investor).
These bonds appeal to the investor who wants a higher yield in their fixed income while also having the option of participating in the underlying stock if it were to go up. Convertible bonds can be converted into common or preferred shares at a price agreed in advance. They’re attractive because they tend to perform well and hold value in both volatile markets and rising rate environments.
Business Development Companies (BDCs)
These firms have filled a gap where traditional banks don’t lend because of tighter standards. They lend to medium-sized businesses at 10-15 percent rates with equity kickers attached to every deal.
That translates to significant dividends for investors because regulations require BDCs to return 90 percent of their income generated to investors.
BDCs tend to perform well in expanding markets with rising interest rates. Yields of 7-10 percent are common. We believe the demand for middle-market financing has some legs and could be a sweet spot for fixed-income investors.
Securities sold through CoreCap Investments, Inc., a registered broker-dealer and member FINRA/SIPC; advisory services offered by CoreCap Advisors, Inc., a registered investment advisor. Cornerstone Financial and CoreCap are separate and unaffiliated entities.