January 2020
Market Update

“What a difference a year makes, right?”  

What a year. 

At the start of 2019, markets faced four significant macroeconomic uncertainties: Could the U.S. and China strike a trade deal? What was the Fed policy for 2019 and would they continue to increase interest rates? Could U.S. and global economies stabilize? Would Brexit get resolved? Each of these unknowns, which had weighed on markets throughout the early part of 2019, saw positive progress during the final three months of the year, resulting in solid gains for the fourth quarter and the best annual return for the S&P 500 index since 2013! 

By far, the most important event for markets during the fourth quarter was the agreement to a “phase one” trade deal by the U.S. and China. Since early 2018, the U.S.-China trade war, and the tariffs that came with it, pressured the global economy and weighed heavily on investor sentiment. Twice in 2019, first in May and again in August, tariff increases caused a significant spike in market volatility. 

Improvement in U.S.-China trade relations wasn’t the only positive event in 2019, however. The Federal Reserve, at the first of the year, had backed off of the idea to continue interest rate increases and announced no further rate increases for 2019. Then followed this change of course with an even more dramatic move, decreasing the short-term bond rates three times, the largest annual reduction in over a decade. Additionally, at the December policy meeting the members of the Federal Open Market Committee showed they do not expect to raise interest rates in 2020. That added clarity for Fed policy expectations, specifically that the market can expect rates to stay low for the foreseeable future, also helped power stocks higher in the fourth quarter. 

By market capitalization, large company stocks outperformed small company stocks for the full year. That reflected investor concerns about a potentially slowing global economy, as large caps are historically less sensitive to slowing growth than small cap stocks. Notably, however, small caps did narrow the performance gap in the fourth quarter, which implied rising optimism towards the global economy in 2020, following the announcement of the U.S.-China trade deal. From an investment style standpoint, growth stocks outperformed value stocks again in 2019, due to strength in the technology sector. Looking internationally, foreign markets registered solidly positive returns, with foreign developed markets modestly outperforming emerging markets. However, both underperformed the S&P 500 in 2019. 

Even bonds fared well last year, as the Federal Reserve’s cuts in interest rates helped lift bond prices and produced stellar returns for most classes of bonds. Many of the components of our Total Return portfolio – high yield bonds, preferred stocks, and non-agency mortgages – all garnered double-digit returns. The Fed’s commitment to keep interest rates stable in 2020 should continue to support bond prices, although we are more tempered in our outlook for this year. 

The markets’ performance in 2019 was a good reminder of the difference a year can make. In January 2019, the S&P 500 was coming out of its first negative year in a decade; worries about the global economy were surging due to the U.S.-China trade war and the Federal Reserve had just hiked interest rates the previous month. For us, the takeaway from this is clear: What happened in the markets last year doesn’t mean much for what could happen in the markets this year. 

And so what do we expect for 2020? 

First, we are monitoring several unknowns that, with the market at historically high valuation levels, could cause volatility in 2020. Regarding U.S.-China trade, markets are now wondering what’s in the phase one trade deal. The text of the agreement should be released in early-January, and while sentiment towards the deal is clearly positive, specific details remain very light. At some point, the market will demand that the details of the trade deal meet now-elevated expectations. 

Turning to the economy, markets are expecting a rebound in global economic growth. So, the upcoming economic data needs to continue to show signs of stabilization and, ultimately, a re-acceleration of economic growth not just in the United States, but globally. 

The Federal Reserve will continue to play a role in the markets this year, despite promising no movement on interest rates. The quiet addition of over $400 Billion to the Fed balance sheet since the middle of September certainly helped lift stock prices in the fourth quarter. This move was in response to stress in the over-night lending market, called the “Repo Market”, used by global banks. Given that this is not a typical event for that market, we are keeping a watchful eye. For more details on what this market is and how this is impacting stocks and bonds, please see our latest Dave Talks on the web site. 

Looking at domestic politics, markets have ignored the impeachment of President Trump and that’s not likely to change as the odds he is removed from office by the Republican-controlled Senate are very low. But there is an election coming in November, and while many analysts don’t expect it to begin to influence the markets until later this summer, we could know who the Democratic nominee is by the end of March. Depending on who that person is, we may see some unexpected volatility in the stock market. 

Meanwhile, on the geopolitical front, we have the unexpected execution of the Iranian general, Qassem Soleimani, leader of Iran’s Islamic Revolutionary Guard Corp, as authorized by President Trump. Soleimani has been described as “the single most powerful operative in the Middle East today” and his position is considered to be second only to the Ayatollah. The impact of this action will be the focus of headlines, a spike in oil prices, and very likely market volatility, in the near term. 

Bottom line, the fundamental outlook for the economy and asset markets has improved since the depths of the 2018 correction, and stocks have responded accordingly. But it’s very important to realize that, despite the strong performance in 2019, markets still face significant uncertainties, and we are committed to monitoring these situations and their impact on the markets and your portfolio. 

If you have questions, please contact us.

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