Insights & Thoughts

4th quarter commentary

Two Years, One Market

Dec 22, 2019 | Quarterly Commentary

2019 turned out to be one of those gangbuster years for the stock market that investors only see a couple of times in a decade. Or so it seemed. In reality, the rally was a continuation of the 2018 market expansion.

Large cap stocks had the best performance with the S&P 500 gaining 29%. This was its best performance since 2013. While not as high, mid-cap and small-cap stocks also had a great year, gaining 24% and 21% respectively. But if you remember, stocks had a sharp sell-off in the fourth quarter of 2018 that erased all the gains that year. Thus, much of the 2019 index gains were really just a retracement of the 2018 correction. Looking at 2018 and 2019 together, the S&P 500 was up a more normal 10.4% per year.

This two-year perspective also holds true when looking at the Fed’s monetary policy. The Federal Reserve raised rates four times in 2018 and then lowered them three times in 2019. The net effect being a modest single quarter point increase over the two years.

The political rhetoric and the news would have you believing otherwise, but by almost all measures (GDP, unemployment, inflation, etc.) the nation is enjoying a solid economy. Cutting through the volatility over the past two years, the stock market gains reflect a healthy economic expansion and not an overbought one ripe for a correction.

This is not to say that 2020 gains are a sure thing. It just means that the risks are no greater than a typical year. A few of the big items that we think will be driving sentiment are the continuing trade negotiations and of course the presidential election.

Trade and tariffs proved to be the biggest driver of volatility in 2019. We think this will hold true in 2020, too. The difference this year is that both sides (U.S. and China) will be under more pressure to either come to some sort of a compromise or at least not inflame the situation. This is because of the political position both leaders find themselves in each country. In the U.S., those pressures are due to the election season and in China, the civil unrest in Hong Kong.

We expect interest rate policies to remain steady as inflation and growth data continue to be within a range the Fed is comfortable with. Interest rates continue to be frustratingly low however and will likely remain that way in the near term.

This has been a serious problem for retirees for a long time now. Typical yields on investment grade bonds are less than half of what they should be at this point of an economic expansion. There are a number of reasons for this, but the biggest is that central banks around the globe are unwilling or unable to unwind their quantitative easing policies dating back to the financial crisis more than ten years ago. Like a drug addict, the financial markets are now firmly hooked on easy money policies and have a fit at any effort to take it away.

What this means for income investors is that you need significantly more savings to retire on. For example, a retiree wanting $8,000 per month would need 1.6 million dollars yielding 6% to generate that income. If the yield were to decrease to 4% (similar to current rates), they would need 2.4 million dollars. That’s hard to overcome and forcing many investors into non-traditional and riskier investments to meet their income needs. Not only is this affecting individual investors but also big institutional investors such as insurance companies, endowments and pension funds.

Looking forward to 2020, there doesn’t appear to be an immediate threat to the market rally. The talk of recession from this summer has all but disappeared. Washington is in its perpetual state of gridlock, thus there aren’t any big legislative initiatives on the horizon. Obviously, the November election results will play a major role in market sentiment. But there still isn’t a frontrunner on the Democratic side so it’s hard to tell what the election will even look like at this time. Our best guess is that interest rates will remain in a similar range as 2019 and stocks will drift higher until we get closer to November.


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