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| Strong consumer spending bolsters U.S. Economy going into 2020. |
Investment Strategy
Analyst with Edward Jones.
Stocks rose in the
final week of 2019, with several major indexes hitting fresh record highs.
Volatility remained subdued, and stocks continued their ascent into year-end,
as there were no catalysts or major economic releases to disrupt the market
rally. The S&P 500 is on track to match the 2013 29.6% return, which was
the best of this decade. Historically, stocks have risen by an average of 7.0%
the following year when the stock market rose by more than 25%, indicating that
good returns don’t have to be followed by bad ones1. However, given full
valuations, we think investors need to incorporate lower expected long-term
rates of return into their strategies.
Source:
Bloomberg, S&P 500 price returns.
2019 in Review: The
Fed, Trade and the End of a Strong Decade
Investment
goals and market cycles do not reset every calendar year, but the end of a year
marks an opportunity for reflection. The one thing that most investors agree on
is that there is never a dull moment when it comes to investing and financial
markets. That proved to be the case in 2019 as stocks managed to climb the wall
of worry, finishing the year and the decade on a high note. While a mosaic of
events and factors typically drive the market narrative and short-term
performance, two stand out this year: 1) the Federal Reserve pivot, and 2)
twists and turns on the U.S. / China trade negotiations. Before digging deeper
into these two factors, here is a look back at the highlights (good and bad) of
2019 and what they could mean for the markets in the year ahead.
A year with plenty
of records, firsts and low points
--34
new record highs – Following a near 20% correction in December of 2018, the
S&P 500 climbed steadily throughout 2019, recording 34 fresh record highs,
with stocks having their best year in more than half a decade. Since 2013 when
the market reclaimed the 2007 high, the S&P 500 has set 271 all-time highs
(an impressive 16% of all trading days), indicating that new highs aren't a
sign of exhaustion.1
--126
months of economic expansion – In June, the U.S. economic expansion surpassed
the one in the 1990s to become the longest on record. The slow and steady pace
of economic growth has likely played a role in this expansion's longevity, with
the economy avoiding the typical overheating that marks the end of the business
cycle, in our view. GDP growth in 2019 is projected to slow to a still-healthy
2.3% (also the average growth over the last 10 years) from 2.9% in 2018.2
--Unemployment
at a 50-year low – Despite heightened uncertainties, consumers remained
confident and continued to spend in 2019, which arguably ties back to the labor
market. The U.S. economy added about 2 million jobs this year, bringing the
unemployment rate down to 3.5%, the lowest level since the late 1960s.2 Rising
wages, a steady uptrend in housing prices, and solid stock-market returns all
have bolstered confidence and continue to do so.
--Zero
10% corrections – Volatility remained depressed throughout the year, with the
S&P 500 experiencing only two modest pullbacks, a 6.8% drawdown in May and
6.1% in August. For historical comparison, corrections in the stock market –
defined as a decline of 10% or more – have occurred, on average, about once a
year. Also reflecting the low degree of fluctuation was that the S&P 500
experienced only seven daily moves (up or down) of 2% or more in 2019, compared
with an average of 19 over the past 20 years.1
--Slowest
global growth in 10 years – Rising trade and geopolitical tensions took a toll
on manufacturing activity, which weakened to levels not seen since the global
financial crisis. As a result, world GDP growth decelerated to around 3%, the
slowest pace in the last decade. Monetary accommodation and a resilient service
sector acted as offsets, supporting employment and stock prices.3
--Record
low 30-year government yields – While stocks tend to capture the spotlight,
bonds also deserve a place at the podium this year. Slower economic growth,
muted inflation, and expectations of central-bank easing drove 30-year
government yields to a record low near 2% and 10-year yields to the lowest
level in three years. As yields fell, bonds recorded the biggest gain in 17
years.2
--$11
trillion of negative-yielding debt – With central banks in Europe and Japan
setting short-term policy rates below zero, negative-yielding bonds grew to
almost $17 trillion in market value ($11 trillion currently), pushing U.S. yields
lower.
--Yield-curve
scare – A portion of the yield curve inverted in March as 10-year rates dipped
below three-month rates for the first time since 2007. This signal, which in
the past has been a reliable, but not infallible, predictor of economic downturns,
triggered fears of an upcoming recession. As economic data showed a slowdown,
but not a collapse, recession fears receded and the yield curve un-inverted.
--Asset-class
scorecard - U.S. large-cap stocks were not only the asset class winner for the
year (+32% total return), but for the decade as well (257% total return, or
+13.6% per year). On the flip side, emerging markets (18%) and commodities
(18.5%) lagged this year (and decade), held back by slowing global growth and
trade uncertainty.4
Implications for
2020:
A)
Edward Jones stock market pros believe economic data will be more balanced and
stock-market gains will moderate as we progress through next year and decade.
Valuations are higher exiting 2019 compared with year-ago levels, yet they are
still at reasonable levels given the economic and interest rate backdrop. With
limited opportunities for further multiple expansion, the pace of market gains
will be set by the pace of earnings growth, which we think will rise at a
mid-single-digit rate.
B)
We expect consumer spending to remain a bright spot in the U.S. economy. Job
growth will likely slow but stay above the 100,000-level necessary to absorb
new entrants in the labor force.
C)
Election uncertainties, trade setbacks and occasionally underwhelming economic
reports will likely stoke higher volatility than investors have been accustomed
to in recent years.
D)
While U.S. large-cap stocks have consistently generated the best returns this
decade, asset-class leadership often rotates. As the cycle advances, we think
well-diversified portfolios will be better positioned to navigate the swings.
E)
Despite ongoing low yields, we still think fixed-income investments play an
important part in helping stabilize portfolios when stocks drop.
A U-turn by central
banks
The
biggest change in the macroeconomic landscape in 2019 was, in our view, the
dovish pivot of major central banks around the world. The Fed, the European
Central Bank (ECB) and the Bank of Japan all became more accommodative to
sustain the economic expansion. This synchronized policy easing was a key
driver of financial markets, contributing to the fall in short- and long-term
interest rates, and benefiting equities. One year ago, the sell-off in 2018 was
driven by concerns that the Fed was overtightening amid escalation in trade
tensions and slowing global growth. Since then, rather than continue to tighten
policy as originally planned, the Fed pivoted to a pause in March and later cut
rates three times as insurance against risks to the outlook.
Implications for
2020:
Easy financial conditions will likely continue to support stock prices next
year. Monetary-policy changes impact the real economy with a lag (typically six
– nine months); therefore, we expect the markets and the economy to continue to
benefit in 2020 from this year's rate cuts. Risks of a further slowdown in
global growth have lessened somewhat in recent months, but inflation remains
stubbornly below target, providing the Fed flexibility to remain accommodative.
Tweets, tariffs and
a truce
Trade
tensions triggered the two most sizable pullbacks in global stocks this year.
Accompanied by a series of tweets in May, President Trump raised tariffs to 25%
from 10% on $200 billion in imports from China. China responded by increasing
tariffs on $60 billion worth of U.S. exports. In another episode of the trade
saga in August, the U.S. announced 10% tariffs on an additional $300 billion
worth of Chinese imports. China responded with $75 billion in new tariffs. The
direct impact of the trade escalation was a drop (but not a collapse) in global
trade volumes. The indirect impact, which potentially carries more economic
significance, in our view, was the deterioration in business confidence and
investment hesitation because of the uncertainty. The emergence of the
"phase one" trade deal between the U.S. and China, which includes
agricultural purchases and some tariff relief, eased fears of further trade
escalation and inspired the market's late-year rally.
Implications for
2020:
We believe that the recent trade truce signals that both countries are
incentivized to compromise to avoid more economic harm. The
"phase-one" agreement could help ease uncertainty, if it lasts, and
act as a catalyst for a modest rebound in global manufacturing activity.
However, we would caution that there could be further setbacks that stoke
market volatility. A comprehensive deal including the more-sensitive issues of
intellectual property rights protection and enforcement will likely not happen
before the 2020 U.S. elections.
A final note
With
days left in 2019 and this decade, we reflect on what has been an eventful and
prosperous year. Heading into 2020, we maintain a fairly positive outlook, but
we believe that the next decade will likely bring plenty more challenges for
investors to navigate. History has taught us, however, that investment
challenges are best navigated with investment discipline and a longer-term
perspective.
From
all of us on the Edward Jones Investment Strategy team, we wish you a happy and
prosperous new year!
Sources:
1. FactSet, 2. Bloomberg as of 12/26/19, 3. IMF World Economic Outlook, October
2019, 4. Morningstar Direct, total return.
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