2019 was one of the best performing years for U.S. stock and bond markets in recent history, however, it was not exactly a comfortable ride. In fact, most of the gains in the S&P 500 Index, which was up 31.5% for the year, occurred during the first and fourth quarters.1 At times, specifically in the Spring and Summer when the market took a pause, it seemed as though investors were on edge waiting for the other shoe to drop. This, of course, never happened and we ended the year with stocks near all-time highs. During our frequent conversations throughout the year, while admittedly sounding repetitive, we reiterated our belief that your specific investment policy alone should dictate your investment strategy and that you should stay committed to the plan.
In this commentary, we will first take a look at the catalysts that influenced the markets in 2019, and then we will highlight the key themes to watch in the year ahead. Over the past few months, the market has benefited from a perceived reduction in risks that had been a source of uneasiness for investors. While some concerns have tempered, new catalysts now take center stage in 2020, such as tensions in the Middle East and the upcoming U.S. elections. However, the fundamental story has not changed much, with the U.S. economy continuing its path of slow and steady growth supported by an accommodative Federal Reserve. We have yet to see the signs that are typically associated with Bear markets (i.e. recession) and thus the now longest economic expansion in history, continues to push ahead.
The S&P 500 achieved 34 record closing highs during 2019. At some point, we expect the headline shock of, “stocks make all-time highs” to fade. The index was not one-directional and the market experienced declines of more than 6% in a short period, in both May and July/August. 1
Heading into 2019, the Federal Reserve indicated that it would raise the Fed Funds rate twice during the year, following four hikes in 2018. What actually transpired was the Fed cut its target benchmark rate three times during the year. This shift in policy provided a significant boost to the U.S. stock market.
The trade war with China had a far-reaching impact on the markets in 2019. Deal / No-Deal news rattled the markets throughout the year. Furthermore, while we may never know the full impact of the tariffs (and threat of tariffs), it’s likely that global growth has suffered due to all of the uncertainty.
The U.S. economy continues to expand. Moderate GDP growth of roughly 2% has persisted over the past two quarters and the current economic cycle has now been in a period of expansion for 101/2 years without a recession. The consumer, supported by the lowest unemployment rate in nearly 50 years, remains a key driver of GDP growth.2
The Treasury yield curve inverted for a short period during the year, when looking at the yield spread between 10-year and 3-month Treasuries. This is often viewed as a recession indicator and its occurrence stirred up market volatility. (See Chart B in Appendix)
The fixed income market experienced its best returns since 2009, with large amounts of money flows into corporate and municipal bond mutual funds. Foreign demand for U.S. bonds is high, as comparative yields in Europe, for example, are lower and negative in some cases. The issuance of municipal bonds was up in 2019 and it was met by the growing demand from investors in high income tax brackets.
KEY THEMES FOR 2020
The yield curve inverted last year in June, but is now positively sloped. Was it a product of the prolonged low interest rate environment and actions of the Fed, and therefore a false recession signal? Or, will the indicator prove once again to accurately predict a recession? An inverted yield curve has historically preceded a recession by roughly 1 year. (See Chart B in Appendix)
The Fed has indicated that it will remain accommodative to the economy. During its most recent meeting, the Fed signaled no forthcoming monetary policy changes while inflation remains below its 2% target. An accommodative Fed has, and should continue to be, positive for the stock market.
A phase-one trade deal with China was signed on 1/15, with negotiations on phase-two expected to start immediately. Trump stated that tariffs would come off after completion of phase-two. Despite the positive momentum in trade talks, we are far away from a comprehensive trade deal and as we learned throughout 2019, “talks” can end quickly. Many uncertainties lay ahead.
U.S. – Iran tensions have subsided for the time being, but we anticipate both countries to be on edge. We should expect heightened market volatility to accompany any increase in conflict. Additionally, it is unknown what the lasting economic impact to the region will be, from increased sanctions and potentially higher oil prices.
President Trump will be working hard on his re-election bid between now and November 3, 2020. Our best guess is that the Trump factor will change during this election year. If the market remains at all-time highs and the economy avoids a recession, come debate time in September and October, we should expect to hear all about it. Nonetheless, we expect the upcoming election to be the most influential known catalyst for the market this year.
Will the economy stay out of recession territory in the near-term? Many fear that a recession is on the horizon, however, we do not believe that is the case. Below, we list a few of the typical indicators of a pending recession and if they are evident today:
A sluggish economy: No - GDP growth is stable, driven by consumer and corporate strength.
Declining confidence: No - consumer sentiment is high and investor confidence has been low, but improving.
Tightening policy: No - we are currently in an easing monetary policy environment.
A declining stock market: No - the stock market is at all-time highs.
At this time each year, we review and update our forward looking capital market assumptions. This is based on an estimate of asset class returns and volatility around those returns over the next 10 - 15 years. While these are simply estimates, based upon historical trends and the current economic environment, they are helpful tools in portfolio construction and in the projections used when developing your plan. We bring this up as a reminder that market risk is a fundamental part of investing and while it is unpredictable, it can be calculated and planned for approximately. Thoughtful portfolio construction and allocation decisions that are based upon your unique set of circumstances, allow us to plan for the unexpected.
Some investors today are fearful of a prolonged market correction, while some investors are hoping for a market pullback in order to add to their investments. Some investors embrace risk, while others fear the volatility. Whether you fall into one of these generic categories or not, our goal is to make sure your investment strategy is designed for and measured against the results of your plan. We look forward to speaking with you in the New Year and will continue to keep you informed of our best thinking as these themes for 2020 evolve.
Chart A: 2019 Total Return of Major Asset Class Indexes
Source: Bloomberg; 2019 Total Return, International, Emerging market, S&P 500, Barclays Agg indexes
Chart B: Yield Curve Inversion (Occurred in June 2019; Has Preceded Past Recessions)
Source: Bloomberg; 10-yr / 3-mth Treasury Yield Spread; Red Shaded Area Indicates Recession
1 - Source: Bloomberg: S&P 500 Index; Emerging Markets Stock Index = MSCI Emerging Markets Net Total Return Index; International Markets Stock Index = MSCI EAFE Total Return Index. Bloomberg Barclays Aggregate Bond Index
2 - Source: Trading Economics US GDP Historical Growth
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