Markets welcomed the positive resolution of several key macroeconomic unknowns in the fourth quarter, and that improved clarity sent the broader stock market higher over the past three months. The solid fourth quarter gains helped the S&P 500 index achieve its best annual return since 2013.
At the start of the fourth quarter, markets were facing four significant macroeconomic uncertainties: Could the U.S. and China strike a trade deal? Would the Fed cut interest rates for a third time in 2019? Could U.S. and global economies stabilize? Would Brexit get passed? Each of these unknowns, which had weighed on markets earlier in 2019, saw positive progress throughout the final three months of the year.
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.
But in mid-October, after intensive negotiations, both the U.S. and China agreed, in principle, to a phase one trade deal that would result in the reduction of some existing tariffs, the promise of no additional tariffs, and increased imports of American goods by China. Anticipation of this “in principle” deal being formally agreed to powered stocks higher from mid-October through mid-December. And then on December 13th, more specific details of the phase one deal were announced, and that clarity helped stocks extend the 2019 rally into year-end.
Improvement in U.S.-China trade relations wasn’t the only positive event in the fourth quarter though. The Federal Reserve met market expectations by cutting its benchmark interest rate by another 25 basis points at the meeting on October 30th. That cut brought the total reduction in interest rates in 2019 to 75 basis points, 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.
The global and U.S. economies also showed signs of stabilization in the fourth quarter after losing positive momentum for much of 2019. First, in the United States, concerns were growing that sluggish business spending and investment would potentially cause a broader economic slowdown. But the market’s preferred measure of business spending and investment, the monthly Durable Goods report, rebounded in the fourth quarter, easing some of those growth concerns. Internationally, measures of Chinese manufacturing activity, which had shown the industry was in contraction for the past several months, turned positive again in December, and that implied activity was stabilizing. So, while concerns remain about the next direction of the global economy, these signs of progress in the fourth quarter helped stocks rally.
Finally, after three-and-a-half years of Brexit uncertainty, investors can finally expect some progress as the mid-December elections in the United Kingdom resulted in a strong conservative (or Tory) party majority. As a result, the Brexit agreement with the EU is expected to pass Parliament in early 2020.
In sum, the fourth quarter of 2019 was a reminder that macroeconomic fundamentals matter, and the positive news on four key macroeconomic fronts fueled a broad rally in the stock market and makes it more likely, but not certain, that we will see improved global economic growth and better earnings in 2020.
The major U.S. stock indices were all solidly higher in the fourth quarter led by the tech-heavy Nasdaq which handily outperformed thanks to rising optimism on U.S.-China trade and expectations for a rebound in economic growth. The S&P 500, Dow Jones Industrial Average and Russell 2000 (the small-cap index) all had smaller, yet positive, quarterly returns. The performance of the major indices in the fourth quarter mirrored the full-year performance, as the Nasdaq easily outperformed the other three indices in 2019 as investors sought the secular growth potential of the tech sector amidst macroeconomic uncertainty.
By market capitalization, large caps outperformed small caps 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 outperformed value again in the fourth quarter due to strength in large-cap tech. That widened the performance gap for the full year 2019, as growth considerably outperformed value, again thanks mostly to strength in the tech sector.
On a sector level, 10 of the 11 S&P 500 sectors finished the fourth quarter with positive returns. Technology, financials and healthcare stocks led markets higher in the fourth quarter, which is a reversal from the defensive sector outperformance we witnessed in the third quarter of 2019. Expectations that the U.S.-China trade deal would lead to better economic growth combined with higher bond yields helped power the rally in tech and financials, while healthcare gained on a reduction in political headwinds as candidates who favor expansion of the government healthcare programs, dubbed “Medicare for all,” dropped in the polls. For 2019, the big fourth-quarter rallies by tech and financials helped those two sectors outperform on a full-year basis.
Sector laggards in the fourth quarter were the traditionally defensive market sectors. Real Estate was the only S&P 500 sector to finish negative in the fourth quarter, while utilities and consumer staples underperformed the S&P 500 as the U.S.-China trade deal caused investors to rotate into sectors that are more sensitive to a potential upswing in global growth. On a full-year basis, energy was the relative sector laggard as market worries about a slowing global economy combined with the potential oversupply of oil weighed on energy shares, although the energy sector still finished 2019 with a respectable annual gain.
Looking internationally, foreign markets saw positive returns in the fourth quarter thanks mostly to the U.S.-China trade deal, although most foreign markets still underperformed U.S. markets. Foreign developed markets posted solid gains in the fourth quarter but lagged emerging market returns. Emerging markets outperformed both foreign developed markets and the S&P 500 in the fourth quarter thanks to rising expectations for a global economic rebound, combined with some declines in the U.S. dollar. For the full year 2019, foreign markets registered solidly positive returns, with foreign developed markets modestly outperforming emerging markets. However, both underperformed the S&P 500 in 2019.
Commodities enjoyed strong gains in the fourth quarter, led higher by a rally in oil while gold saw a more modest rally over the past three months. Oil prices rose in the fourth quarter thanks to the decision by “OPEC+” to deepen production cuts this year, combined with the U.S.-China trade deal raising expectations for global growth and future oil demand. Gold, meanwhile, spent much of the fourth quarter in negative territory as investors rotated out of the safe-haven metal and into more risky assets following the de-escalation of the U.S.-China trade war. But, a late-year decline in the U.S. Dollar, combined with a mild increase in geo-political tensions, helped gold rally late in December and register a positive return for the quarter. For 2019, commodities produced positive returns which were driven by a large gain in the price of oil, although commodities as an asset class lagged the S&P 500 on a full-year basis.
Switching to fixed income markets, the total return for most bond classes were positive in the fourth quarter, although longer-dated Treasuries saw mild declines, which is not surprising given rising expectations for a rebound in global growth. The leading benchmark for bonds (Bloomberg Barclays US Aggregate Bond Index) experienced slightly positive returns for the fifth straight quarter.
Looking deeper into the fixed income markets, longer-duration bonds underperformed those with shorter durations in the fourth quarter which was a reversal from most of 2019. That is reflective of a market that is responding to the recent Fed rate cuts and beginning to expect a rebound in global economic growth going forward.
Confirming that improved sentiment, corporate bonds saw solidly positive returns in the fourth quarter as high yield debt outperformed investment-grade debt. The outperformance of lower-quality but higher yielding corporate debt also underscored rising optimism about future economic growth and corporate earnings.
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.
Now, we begin 2020 on the opposite end of the spectrum.
The S&P 500 just registered its best annual return since 2013, worries about the global economy are receding thanks to the U.S.-China trade deal and the Fed cut interest rates three times in 2019.
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.
Put in more familiar phrasing: Past performance is not indicative of future results.
So, while the macroeconomic environment is favorable as we begin 2020, a new year always brings new challenges and uncertainties, especially when it’s an election year.
More specifically, as we begin 2020, 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.
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, it could cause unexpected volatility. Meanwhile, on the geopolitical front, we have relative calm, although tensions with North Korea and Iran are potentially rising.
Bottom line, the fundamental outlook for the economy and asset markets has improved since the depths of the 2018 correction, and there is still no major evidence of an economic recession, so we remain invested accordingly. But it’s very important to realize that, despite the strong performance in 2019, markets still face significant uncertainties, and short-term market corrections can occur at any time. We are committed to monitoring these situations and their impact on your portfolio.
At Munn & Morris Financial Advisors, we’ve been through both good and bad markets, and those experiences ensure that we guard against complacency following a year of strong annual returns. We remain committed to helping you navigate this ever-changing market environment, with a focused eye on ensuring we continue to make progress on achieving your long-term investment goals.
Please do not hesitate to contact us with any questions, comments, or to schedule a portfolio review.
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The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered representative of the U.S. stock market. The Dow Jones Industrial Average (DJIA), commonly known as “The Dow” is an index representing 30 stock of companies maintained and reviewed by the editors of the Wall Street Journal. The NASDAQ composite is an unmanaged index of securities traded on the NASDAQ system. The S&P MidCap 400® provides investors with a benchmark for mid-sized companies. The index, which is distinct from the large-cap S&P 500®, measures the performance of mid-sized companies, reflecting the distinctive risk and return characteristics of this market segment. The Russell 2000 Index measures the performance of the 2,000 smallest companies in the Russell 3000 Index, which represent approximately 8% of the total market capitalization of the Russell 3000 Index. The MSCI EAFE is designed to represent the performance of large and mid-cap securities across 21 developed markets, including countries in Europe, Australasia and the Far East, excluding the U.S. and Canada. The Index is available for a number of regions, market segments/sizes and covers approximately 85% of the free float-adjusted market capitalization in each of the 21 countries. The MSCI Emerging Markets Index captures large and mid-cap representation across 24 Emerging Markets (EM) countries*. With 1,151 constituents, the index covers approximately 85% of the free float-adjusted market capitalization in each country. * EM countries include Brazil, Chile, China, Colombia, Czech Republic, Egypt, Greece, Hungary, India, Indonesia, Korea, Malaysia, Mexico, Pakistan, Peru, Philippines, Poland, Qatar, Russia, South Africa, Taiwan, Thailand, Turkey and United Arab Emirates. The MSCI ACWI Index is designed to represent performance of the full opportunity set of large- and mid-cap stocks across 23 developed and 24 emerging markets.1 As of March2018, it covers more than 2,400 constituents across 11 sectors and approximately 85% of the free float-adjusted market capitalization in each market. The S&P GSCI is a composite index of commodity sector returns, which represents a broadly diversified, unleveraged, long-only position in commodity futures. The S&P GSCI is intended to provide exposure to broad-based commodities. S&P GSCI Crude Oil is an index tracking changes in the spot price for crude oil. The LBMA Gold Price (“Benchmark”) is owned by London Bullion Market Association (LBMA) and ICE Benchmark Administration (IBA) provide th auction platform, methodology as well as the overall administration and governance for the LBMA Gold P rice. The Barclays Capital US Aggregate Index is an unmanaged market value weighted performance benchmark for investment-grade fixed rate debt issues, including government, corporate, asset backed, mortgage backed securities with a maturity of at least 1 year. The
Barclays Capital 1-3 Month U.S. Treasury Bill Index includes all publicly issued zero-coupon U.S. Treasury Bills that have a remaining maturity of less than 3 months and more than 1 month, are rated investment grade, and have $250 million or more of outstanding face value. In addition, the securities must be denominated in U.S. dollars and must be fixed rate and nonconvertible.
The ICE U.S. Treasury 7-10 Year Bond Index is part of a series of indices intended to assess the U.S. Treasury market. The Index is market value weighted and is designed to measure the performance of U.S. dollar denominated, fixed rate securities with minimum term to maturity greater than seven years and less than or equal to ten years. The ICE U.S. Treasury Bond Index Series™ has an inception date of December 31, 2015. Index history is available back to December 31, 2004. The Bloomberg Barclays US Mortgage Backed Securities (MBS) Index tracks agency mortgage backed past through securities(both fixed-rate and hybrid ARM) guaranteed by Ginnie Mae (GNMA), Fannie Mae (FNMA), and Freddie Mac (FHLMC). The index is constructed by grouping individual TBA-deliverable MBS pools into aggregates or generics based on program, coupon and vintage. The Bloomberg Barclays U.S. Municipal Index covers the USD-denominated long-term tax-exempt bond market. The index has four main sectors: state and local general obligation bonds, revenue bonds, insured bonds and pre-refunded bonds. The Bloomberg Barclays US Corporate Bond Index measures the investment grade, fixed rate, taxable corporate bond market. It includes USD denominated securities publicly issued by US and non-US industrial, utility and financial issuers. The Bloomberg Barclays US Corporate High Yield Bond Index measures the USD-denominated, high yield, fixed rate corporate
bond market. Securities are classified as high yield if the middle rating of Moody’s, Fitch and S&P is Ba1/BB+/BB+ or below. Bonds from issuers with an emerging markets country of risk, based on Barclays EM country definition, are excluded.