|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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