QUARTERLY MARKET UPDATE as of January 2020
Stocks had a strong quarter with the S & P 500 gaining 9.1% to finish out the year and decade on a very positive note. All sectors except real estate finished higher with the best returns in Technology and Healthcare, each moving up over 12%. Small Caps and International stocks also had solid returns, with the Russell 2000 advancing 9.9% and the MSCI EAFE index gaining 8.2%. Intermediate and long-term interest rates increased as recession fears have faded. The 10-year Treasury note ended the quarter about ¼ point higher at 1.90%. Improving prospects for global trade, low unemployment, and the Fed keeping short term rates unchanged at their latest meeting boosted confidence and were the main contributors in moving the markets.
The Fed lowered rates three times last year, with the last cut back in October. Typically there is an economic lag with an interest rate cut. The benefits may take six to nine months to show up. That may bode well for sustaining the economy throughout this quarter. With inflation continuing to be under control the Fed is not expected to raise rates, and has increased a bias towards lowering rates if necessary. The latest core personal consumption expenditures index increased 2.1%, but only by 1.6% year over year. The Fed’s goal is for a 2% inflation rate, but would prefer to err on the side of higher inflation. It would be easier to raise rates if inflation surged instead of trying to stimulate a slow economy when rates are already low. That is one of the chief concerns for all central banks in our ultra-low interest rate environment.
Unemployment dropped to 3.5% last month on a surprisingly large addition of new jobs. Hiring increased by the largest amount since last January. This has brought a surge of confidence and optimism. The new “Phase 1” trade deal between China and the U.S. and the signed U.S. – Mexico – Canada trade agreement brought hope that the global tariff war is waning, and more deals will follow.
That backdrop brings optimism into the New Year, but much will have to be accomplished before this becomes a trend. Until the Phase 1 deal is signed, renewed trade hostilities are possible. We have already seen this type of back and forth happen last year. The dollar amount of agricultural goods to be purchased by China may violate WTO rules, and details on this agreement have not yet been solidified. The U.S. is also looking to significantly increase tariffs on French imports to combat recent taxes on tech giants. While confidence is high on improving trade deals and possibly lower tariffs, we still have a way to go before hope becomes reality.
Current fundamentals actually make us somewhat cautious. Our economic expansion has continued uninterrupted for over ten years, the longest in history. While we do not see the economy moving towards a recession, the rate of growth is expected to slow. U.S. GDP is expected to increase by a 2% rate this year, from 2.2% in 2019, according to the latest release from the Federal Open Market Committee in December. U.S. stocks have had quite the run the last few years, with several new record levels being set. In the past we have not been deterred by new record highs in the market as long as earnings support the gains. But current valuations are getting stretched. Last year at this time the market forward price earnings ratio (P/E) was at an average historical level just above 15. Now it is just below 19. More overall upside in stocks may be in store, but the risk levels have increased, especially for “growth” stocks. We see an increased probability of a bifurcation in the performance of investment styles this year.
The market started to shift its weight to “value” and defensive style stocks at times last quarter and we expect that style drift to continue. As interest rates still remain relatively low, quality value and defensive stocks paying dividends and trading at reasonable valuations should outperform bonds. We also see investors migrating towards international stocks. In recent years U.S. equities have outperformed international equities. As valuations are more reasonable in many international markets, we expect both developed international stocks and emerging markets will outperform. The stability and strength of the U.S. dollar contributed to this outperformance over the last few years which we now see as reversing course. A continued pickup in global manufacturing should allow the dollar to weaken which will be especially helpful to emerging markets.
Volatility was off last quarter and we would not be surprised to see it return. But we will continue to adhere to sound economic fundamentals to support our investment decisions rather than periodic price swings.