Financial markets finished the year near all-time highs, wrapping up a decade marked almost exclusively by bull markets. The S&P 500 Index gained another 9.06% in the fourth quarter, resulting in an overall gain of 31.48% for the U.S. benchmark in 2019. While it should be noted that this stellar year came off a low base thanks to a relatively large market downturn in December 2018, it still proved to be a year of strong economic growth and multiple expansion, with markets resilient against trade and political uncertainties. As was often the case in 2019, growth stocks outperformed their value counterparts in the fourth quarter, though the gap between the two did narrow in the second half of the year. Healthcare and technology stocks significantly outpaced many other sectors, while real estate and utilities lagged notably. Small-caps finished the quarter as the top performers, followed by large-caps and then mid-caps.
While there was some variation across international markets, broadly speaking the group had a very positive fourth quarter. Emerging markets equities tended to outpace their developed counterparts, with China benefitting from positive developments in trade talks with the U.S. and Brazil moving higher on the passage of a pro-market pension reform bill. The United Kingdom bounced back strongly in the quarter after a recent period of stagnation, as a relatively decisive election gave hope that the nation might finally be able to put the uncertainty surrounding Brexit in the rearview mirror.
Accommodative central bank policies globally and low corporate default rates helped keep yields historically low in the fixed income space, with the 10-year Treasury yield finishing the year at just 1.92%. While the yield curve does remain relatively flat, it is no longer inverted, an important development at least psychologically for investors. The current low rate environment has continued to lead yield-seeking investors towards more risk-on areas of the bond market, and high-yield debt was a top performer in the period. On a duration basis, short- and intermediate-term bonds tended to outperform the longest-dated issues. These patterns generally held true for both corporate and municipal bonds in the fourth quarter.
Outlook – Even with the unprecedented length of the current bull market, we remain cautiously optimistic moving forward. We have no reason to believe that consumer spending cannot continue to drive the domestic economy, especially with unemployment rates as low as they are. This strong consumer spending should help translate into corporate earnings, which are expected to return to positive territory next year with consensus estimates coming in at the high single-digit range. Even if this rosy outlook does not fully materialize, the Federal Reserve has shifted to an accommodative footing and stands ready to step in with more accommodative monetary policy to backstop markets if conditions do in fact weaken. The United States and China are as close to stabilizing trade relations as they have been in years and an end may finally be in sight for the prolonged drama of Brexit. All this being said, the approach of the 2020 presidential election is going to have a real impact on investor sentiment and could create temporary overhangs depending on the prevailing narrative at any one time. Still, absent a victory by a candidate likely to truly rattle financial markets such as Elizabeth Warren, we don’t expect any major disruptions on this front.
We are a bit less bullish on international markets, as reflected by our relatively low current allocation to foreign equities. Even with the potential resolution of major political question marks such as the China trade deal and Brexit, population dynamics and fiscal policy structures in developed markets like Japan and Europe appear likely to continue to constrain growth moving forward. Meanwhile, the rising importance of China, in terms of both its growing economic influence globally and its increasing size in most international indices, raises further questions over the contamination of anti-competitive practices and state control on foreign markets more broadly.
Despite these risks, there are still a number of positive catalysts that could propel international markets higher moving forward. In fact, the U.S. and China have already taken the first steps towards reconciliation with the signing of a first phase trade deal on January 15th. This will benefit not just the U.S. and China, who are directly embroiled in the dispute, but also many European firms whose supply chains and revenues are heavily intertwined with both economies. Perhaps most importantly, as with the U.S., global central banks almost across the board remain accommodative and prepared to step in to boost financial markets should the need arise. Though rates are already negative in many foreign markets, this continued loose stance by monetary policymakers should continue to act as a safety net.
As we mark the end of a decade that encapsulated the longest bull market in U.S. history, with the S&P 500 Index rising well over 300%, we would like to take this opportunity to emphasize the importance of viewing financial markets through a long-term lens. Investors who attempted to cut their losses in the depths of the 2009 financial crisis missed out on at least the early leg of the subsequent recovery, while others who “panic sold” due to factors like the U.S. credit rating downgrade of 2011, 2016 election uncertainties, the 2019 yield curve inversion, or any of a number of other highly publicized headwinds likely ended up leaving gains on the table. None of this is to say that recessions are a thing of the past or that the current bull market will continue uninterrupted forever. We will continue to experience market corrections and economic recessions. The point is simply that the entire basis for investing is a trade-off between risk and reward, and these competing factors must be balanced with a proper long-term allocation rather than swinging from one extreme to another. As famed investor Peter Lynch puts it, “Far more money has been lost by investors preparing for corrections, or trying to anticipate corrections, than has been lost in corrections themselves.” This is the reason the vast majority of clients have both stocks and bonds in their portfolios and why the balance of the two is based on individual risk tolerance and long-term planning needs rather than the next round of trade talks or election cycle. As we head into this new decade, we wish you and yours all the best and thank you for your continued trust.