2019 Fourth-Quarter Market Update & Outlook
Rebounding from late 2018 lows, stocks posted the strongest gains since 2013. The Federal Reserve’s (Fed) decision to reverse course and lower interest rates benefited bonds, which also produced above-average returns. The economy continues to grow at a slow but steady pace—a trend that should continue in 2020.
- HOW DID THE U.S. ECONOMY DO IN 2019?
Weakening manufacturing data prompted concern that the economy was headed for a downturn in the second half of the year. This weakness was caused primarily by two factors: a strike at General Motors, which resulted in a reduction in automobile output, and the effect of the ongoing trade dispute with China. The GM strike has been resolved, and progress has been made in negotiations with China; therefore, activity should start to improve. Meanwhile, the much larger services sector continues to expand, albeit at a declining rate.
Despite increased recession fears, economic growth was steady in 2019, led by strength in consumer spending. The first quarter was the strongest, with the economy growing by 3.1 percent. The second and third quarters showed similar results of 2 percent and 2.1 percent respectively, bringing the 2019 average to 2.4 percent. We expect the slow but steady pace to continue in 2020, extending the longest expansion in U.S. history.
- WHAT FUELED THE STRONG YEAR FOR STOCKS?
Several factors combined to “supercharge” stock market returns in 2019, including these:
- Stocks were cheap entering 2019 after the late 2018 sell-off
- The Fed changed course and lowered interest rates three times, creating a tailwind for stocks and other assets
- Progress was made in trade negotiations with China
- The economy avoided recession and continues to grow at a reasonable pace
Combining 2019’s strong results with 2018’s negative returns produces more ordinary performance. U.S. stocks averaged 12 percent over that two-year period, while global stock returns were 7 percent.
- WHAT IS THE OUTLOOK FOR FED POLICY IN 2020?
Fed policy was a major influence on the markets in 2019. The Fed’s decision to lower rates was a key catalyst in pushing stocks higher. Last year’s rate cuts were meant to be “insurance” to protect economic growth. After cutting rates for the third time in October, the Fed indicated it would remain on the sidelines for a while. This removes uncertainty, which is a positive. The Fed has incentive to maintain rates at current levels to allow room to ease in the next recession. Stable interest rates generally are good for the stock market and neutral for bonds.
If the Fed were to change course at some point in 2020, the next move would most likely be a cut, as economic growth is unlikely to be strong enough to cause a spike in inflation. With that said, Fed policy should not be a hinderance to the markets in 2020.
- HOW WILL RECENT POLITICAL BREAKTHROUGHS AFFECT THE MARKET?
December offered two very positive developments on the political front—a phase-one trade deal and a resolution regarding Brexit. The U.S. and China agreed to a small deal on trade, rolling back some recent tariffs. However, the most important change was the tone of discussions. Prior to December, antagonism was increasing, with both sides ratcheting up pressure. But now, both parties seem intent on finding common ground. President Trump is scheduled to travel to China in the first quarter to begin negotiations on phase two. The move away from hostility has been positive for the global economy and markets and improves prospects for growth in 2020.
The resounding Conservative Party election win in December paves the way for the United Kingdom to officially leave the European Union. This development reduces the risk of economic chaos there. While not as important from a global perspective as the trade deal, it does boost economic and market prospects for Europe. These two political breakthroughs reduce downside risk to the global economy and translate to a better outlook for global stocks.
- AFTER A GREAT 2019, WHAT SHOULD INVESTORS EXPECT IN 2020?
In our last year-end commentary, we addressed the nearly 20 percent decline in stocks that occurred during the final months of 2018. While that was one of the most severe “non-recessionary” market drops in 70 years, we noted that healthy underlying fundamentals created optimism for 2019. Positive factors at the time included strong profit gains, decent economic growth trends, solid employment conditions and an attractive price-to-earnings ratio of 14.5 times for U.S. stocks. While these factors did not guarantee a good year in 2019, the odds seemed favorable for investors.
The optimism was well rewarded in 2019, with market returns exceeding even the loftiest of expectations for the year. Global stocks gained more than 26 percent—the best year since 2013.1 Bonds also produced strong results, as the Feds lowered interest rates significantly. This led to well-above-average diversified portfolio returns for the year.
Does the dramatic rise in stocks set us up for disappointment in 2020? Viewed on a standalone basis, 2019 market performance is a bit concerning; stocks rose nearly 30 percent, while earnings grew less than 5 percent—not a great recipe for future gains! But remember, the opposite occurred in 2018; stocks declined 5 percent, while earnings rose nearly 25 percent. Taken together, combined 2018 and 2019 profit and stock price performance paints a much more encouraging picture2:
- Revenues grew by 12 percent over this two-year period
- Earnings per share grew by 24 percent cumulatively
- Total stock returns were 24.1 percent
This perspective illustrates that 2018 to 2019 market performance was matched by earnings growth, which is a healthy condition. This also means that valuation remains about the same as it was two years ago, with a price-to-earnings multiple of about 18 times 2020 expected earnings.
Keep in mind the first portion of 2019’s robust market gain was a bounce back from the prior year’s decline. So, even though the economic backdrop remains constructive, investors should expect lower returns from stocks in 2020. Given that the Fed intends to keep interest rates stable but low this year, bonds also are destined to produce more modest gains.
U.S. elections, ongoing trade negotiations, escalating federal debt and a host of other issues almost guarantee more rounds of volatility in 2020. The road to further investment gains will get bumpy at times—but diversification across asset classes provides a nice shock absorber, and the outsized returns of 2019 afford a nice cushion as well!
Thank you for the confidence you have placed in your BKD Wealth Advisors team. We look forward to making more progress together in the new year!
Jeffrey A. Layman, CFA® – Chief Investment Officer
Andrew Douglas, CFA® – Senior Portfolio Manager
BKD Wealth Advisors, LLC is an SEC-registered investment adviser offering wealth management services for affluent families and investment consulting services for institutional clients and is a wholly owned subsidiary of BKD, LLP. The views are as of the date of this publication and are subject to change. Different types of investments involve varying risks, and it should not be assumed that future performance of any investment or investment strategy or any noninvestment-related content will equal historical performance level(s), be suitable for your individual situation or prove successful. A copy of BKD Wealth Advisors' current written disclosure statement is available upon request.