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A Tale of Two Viewpoints

by Victor K. Lai, CFA


Unlike 2018, markets got their Santa rally in 2019. The global stock market climbed +28% as measured by the MSCI ACWI Index. US stocks led the way with the S&P 500 up +32%. Foreign equities represented by the MSCI EAFE and EM indices trailed with +24% and +20%, respectively. Even the Barclays US Aggregate Bond Index notched a 9% total return.

Figure 1: Market Returns


After a banner year for the markets, some are celebrating all-time highs while others are fearing the lows to come. As Charles Dicken’s famously wrote, “It was the best of times, it was the worst of times…” Markets are starting 2020 with a tale of two very different viewpoints. We’ll look at the opposing sides in this letter.


First, let’s review my viewpoints from the past year. As usual, I was both right and wrong but ended up ahead overall. In December 2018, a sudden stock market free-fall caused many investors to believe we were headed into a major crash. I did not believe that was the case and wrote the spike in volatility was actually quite normal. I believed the selling was technical in nature, fundamentals were sound, and markets would recover to new highs. Fortunately, that was right on all counts.

On the other hand, my opinions on emerging market equities and silver prices were mixed. Although both emerging market equities and silver prices were up double digits for the year (+20% and +16%, respectively), they also lagged global equities which advanced +28% (thanks to the US). Ironic that in a raging global bull market the best active decision was to passively hold the S&P. In that respect, I was just wrong.


Hindsight is 20/20, but looking ahead into 2020 is less clear and there are at least two paths forward. On path number one it’s certainly possible the longest expansion and bull market in history will continue to make new records. Denying that possibility could be as costly as moving to all-cash at year-end 2018. The most convincing reasons for this viewpoint in the US are consumption and employment.

Consumption makes up the largest component of the U.S. economy, more than two-thirds of GDP, shown in Figure 2 below. This is common in developed economies and it means the biggest driver of our economic activity is people buying goods and services.

Figure 2: US Economy

The most important factor supporting consumption is employment. People tend to keep buying so long as they are gainfully employed. From that perspective, the US economy is in great shape. Unemployment is bouncing around all-time lows and consumption continues to tick up.

Figure 3: Unemployment

Figure 4: Consumption (USD Billions)

We can add to that a number of potential upside catalysts. What if the Fed moves to cut rates? And what if there is a better than expected trade deal or a surprise tax cut? All of these things have the potential to prolong the economic expansion and market rally.

Path number two is less pleasant but no less likely. While the US consumer has held up, businesses are being weighed down. Business confidence has reached the lowest levels of the past decade (represented by ISM PMI below) and industrial production has turned negative in 2019.

Figure 5: US ISM Purchasing Managers Index


Figure 6: US Industrial Production

The most likely culprit is the lingering trade war. Not only have earnings moderated, but it’s also difficult to plan major business expenditures and investments with policy uncertainty. To date, businesses have absorbed much of the trade war casualty through adjustments in volume, foreign exchange, and profits. However, that cannot go on indefinitely. Left unresolved, the impact will inevitably spill over to jobs and consumption.

True, the job market looks strong, but unemployment is also a lagging indicator. By the time it rises meaningfully the economy is typically already in contraction and the market already well off its peak. Initial Jobless Claims, on the other hand, tend to bottom and trend upwards prior to recessions. Currently, it looks like Claims may have bottomed in April of 2019 and a continued uptrend would signal trouble ahead.

Figure 7: Initial Jobless Claims

And of course, there’s the most popular leading indicator of them all, the Treasury Yield curve. So popular, the NY Fed has a recession probability model based solely on the spread between the 10-year Treasury bond and 3-month Treasury bill yield. The curve has recovered from inversion, however, as a leading indicator, it typically has done so before recessions begin (shown as grey bars in Figure 8).

Figure 8: Treasury Yield Curve

And about that NY Fed model, it hit the highest level of the past decade in November 2019 (Figure 9).

Figure 9: NY Fed Recession Probability Model

In addition to those warning signs, other potential downside catalysts include an escalation of aforementioned trade tensions, heightened military conflict in the middle east, and of course a disorderly outcome to President Trump’s impeachment saga. There is no shortage of risks, to say the least.

But for the record, I don’t think we’re headed straight into a recession in the New Year. I don’t see enough widespread deterioration across leading indicators as of now, but all paths considered I also prefer the cautious route. The precise timing of market turns is always uncertain but we’re clearly 28% closer than we were this time last year. At the same time, we’re late in the business cycle with high valuations. Historically not the best environment to be reaching for risk and returns.

Our positioning in the new year is cautiously optimistic, with an emphasis on cautious. That means maintaining strategic allocations with no oversized bets, no overweight to risk assets, and decisive readiness to reduce equity exposure when economic and market conditions deteriorate.


Compelling values remain elusive in 2020. But for those with enough risk appetite, there are still some reasonable opportunities in markets and assets that were left behind by the global risk-on rally.

Unpacking good and bad in Pakistan

The Pakistani stock market is one such position we entered in 2019. I published an article on the position in August 2019 at Seeking Alpha. In 2019, Pakistan’s market was down by more than 70% from its 2017 highs.

Figure 10: PAK Price Return

There was a litany of reasons why Pakistani stocks suffered and why Pakistan was not an ideal place to invest including corruption, currency devaluation, inflation, potential default, slowing economic growth, and austerity imposed by an IMF bailout to name a few. Investors feared this brew had the aroma of a financial crisis and as usual they were selling first and asking questions later.

But meanwhile, I was asking what frantic sellers may have missed. Despite the fear-mongering, the numbers coming out of Pakistan were less dismal than the headlines projected – consider “slowing” GDP of 5%+ versus 2% in developed countries (and with less debt at that). At the same time, a new political regime focused on reform and substantial foreign capital infusions via the IMF and the China Pakistan Economic Corridor (CPEC) looked supportive.

All things considered, I believed selling in Pakistan was overdone. Pakistani stocks (as measured by Global X MSCI Pakistan ETF, PAK) were trading at 5.89x trailing earnings, a 57% discount to emerging market stocks (EEM) and 69% versus global stocks (ACWI). Similar relative valuations were seen across the board.

Figure 11: Price Multiples

Source: Morningstar,, BCM, as of September 1, 2019

Even against frontier markets (FM), one of the least expensive equity market groups in the world, Pakistan traded at a 45% discount based on earnings. The discount widened to 77% based on revenue. With global stocks trading at 19x earnings it's just hard to say Pakistan didn’t look cheap on a relative basis. Since September 2019 my vehicle of choice, PAK, rallied +39% from $5.86 to over $8. My fair value target was ~$11 implying further upside from here.

But again, timing is always the hardest part. I don’t know if September marked the bottom or if we’ll see a new low ahead. My guess is we’ll at least see some profit-taking. Regardless, PAK seemed like a compelling value when I entered the position and remains reasonably so now. I think a long, a patient position at current prices or better will be rewarded over time.

Silver still shining

Another position I favor, carried over from 2019, is precious metals in general and silver in particular. After years of lackluster performance, silver finally managed to notch an annual gain in 2019. From its 2019 bottom in June, my vehicle of choice SIVR shot up 36% into September. It subsequently gave a good chunk back but still managed to end the year up 15%.

Figure 12: SIVR 2019 Price

My fundamental case for silver from last year’s letter is still intact. Speculation about inflation seems to be the primary driver of short-term silver prices (more so than supply and demand). As I suspected inflation did creep up over the past year.

Figure 13: US Inflation Rate

Not only that but as Richard Bernstein Advisors points out, the five-year trend in inflation as measured by (Core CPI) is the highest it’s been in 30 years (Figure 14). Is it another coincidence that silver prices are again spiking on higher than expected inflation? I think not.

Figure 14: US Trend Core CPI (5 Year)

Despite this leg up, silver prices are still well off their 2011 highs of over $40 per oz. With the gold to silver still hovering over 80x (85x most recently) fair value for silver could very reasonably be north of ~$30 per oz (based on the long-term average of 47x). That implies over 90% upside for SIVR from its current $17 handle. Point being, silver continues to be one of my favored positions heading into 2020.

Return of volatility

In 2017 I wrote one of the only significantly undervalued investments I saw was volatility, which wasn’t really an investable asset, to begin with. The closest we could get was derivative-based products that tracked the CBOE Volatility Index, aka the “VIX.”

The VIX went on to spike by over 355% in early 2018 and ended that year up over 130%. Our vehicle of choice VXX was an imperfect proxy but still managed to gain 102% and 72%, respectively.

While the VIX does not look as undervalued as it did in 2017, it’s still relatively low from a historical perspective. With global equity prices inflated and seemingly complacent, the VIX again looks like one of the few undervalued opportunities around.

Figure 15: CBOE Volatility Index

Volatility is, of course, unpredictable by nature. Products offering exposure to the VIX are imperfect proxies and it’s important to understand their idiosyncrasies. My preferred vehicle, however imperfect, continues to be VXX. My intention is not to buy and hold VXX long-term (it’s terrible for that purpose) but to trade it opportunistically throughout the year to profit from volatility spikes and to hedge against drawdowns in other equity positions. To that end, I’ll certainly need some good luck!


Things have certainly come full circle in the course of a decade. Entering 2010, the world was reeling from the aftermath of the global financial crisis and many investors wanted nothing to do with the equity markets. In January 2020 both investor spirits and global equity markets are making new highs.

There is certainly much to be optimistic about for the decade ahead. However, it is also foolish to allow bright-eyed optimism to overlook mounting risks. Investors are truly in a tale of two very different viewpoints and only time will tell how the story unfolds.

Our position at BCM is that of increasingly cautious optimism. Though we are maintaining our strategic risk targets heading into 2020, we expect our next move to be a reduction of risk exposure and are postured to do so when economic and market conditions warrant.

For the risk-seeking, I see relative value opportunities in select equity markets, precious metals, and the VIX. If you take positions, do your due diligence, build on price weakness over time, and don’t bite off more than you can stomach.

Whatever your position, thank you for reading. As always, all of us at BCM want to thank all our clients, family, friends, and those who support us. We truly appreciate your trust and confidence, and we look forward to continuing building on them for decades to come. We wish you all the very best in 2020.

Be Great,

Victor K. Lai, CFA

Bellwether Capital Management LLC (BCM) is a registered investment adviser (RIA). It provides investment management and consulting services for people and organizations. Please visit to learn more.


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