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January 14, 2020 | sistoadmin

Trade Clarity and Interest Rate Cuts Lead to Big Returns in 2019

Markets welcomed the positive resolution of several key macroeconomic unknowns in the fourth quarter, and that improved clarity sent the broader stock market higher over the past three months. The solid fourth quarter gains helped the S&P 500 index achieve its best annual return since 2013.  

At the start of the fourth quarter, markets were facing four significant macroeconomic uncertainties: Could the U.S. and China strike a trade deal? Would the Fed cut interest rates for a third time in 2019? Could U.S. and global economies stabilize? Would Brexit get passed? Each of these unknowns, which had weighed on markets earlier in 2019, saw positive progress throughout the final three months of the year.  

By far, the most important event for markets during the fourth quarter was the agreement to a “phase one” trade deal by the U.S. and China. Since early 2018, the U.S.-China trade war, and the tariffs that came with it, pressured the global economy and weighed heavily on investor sentiment. Twice in 2019, first in May and again in August, tariff increases caused a significant spike in market volatility.  

But in mid-October, after intensive negotiations, both the U.S. and China agreed, in principle, to a phase one trade deal that would result in the reduction of some existing tariffs, the promise of no additional tariffs, and increased imports of American goods by China. Anticipation of this “in principle” deal being formally agreed to powered stocks higher from mid-October through mid-December. On December 13th, more specific details of the phase one deal were announced, and that clarity helped stocks extend the 2019 rally into year-end.

Improvement in U.S.-China trade relations was not the only positive event in the fourth quarter. The Federal Reserve met market expectations by cutting its benchmark interest rate another 25 basis points at the October meeting.  That cut brought the total reduction in interest rates in 2019 to 75 basis points, the largest annual reduction in over a decade. Additionally, at the December policy meeting the members of the Federal Open Market Committee showed they do not expect to raise interest rates in 2020. That added clarity for Fed policy expectations, specifically that the market can expect rates to stay low for the foreseeable future, also helped power stocks higher in the fourth quarter.  

The global and U.S. economies also showed signs of stabilization in the fourth quarter after losing positive momentum for much of 2019. First, in the United States, concerns were growing that sluggish business spending and investment would potentially cause a broader economic slowdown. However, the market’s preferred measure of business spending and investment, the monthly Durable Goods report, rebounded in the fourth quarter, easing some of those growth concerns. Internationally, measures of Chinese manufacturing activity, which had shown the industry was in contraction for the past several months, turned positive again in December, and that implied activity was stabilizing. So, while concerns remain about the next direction of the global economy, these signs of progress in the fourth quarter helped stocks rally.    

Finally, after three-and-a-half years of Brexit uncertainty, investors can finally expect some progress as the mid-December elections in the United Kingdom resulted in a strong conservative party majority. As a result, the Brexit agreement with the EU is expected to pass Parliament in early 2020.  

In sum, the fourth quarter of 2019 was a reminder that macroeconomic fundamentals matter, and the positive news on four key macroeconomic fronts fueled a broad rally in the stock market and makes it more likely, but not certain, that we will see improved global economic growth and better earnings in 2020.

1st QUARTER and 2020 MARKET OUTLOOK

The markets’ performance in 2019 was a good reminder of the difference a year can make. In January 2019, the S&P 500 was coming out of its first negative year in a decade; worries about the global economy were surging due to the U.S.-China trade war and the Federal Reserve had just hiked interest rates the previous month.  

Now, we begin 2020 on the opposite end of the spectrum.  

The S&P 500 just registered its best annual return since 2013, worries about the global economy are receding thanks to the U.S.-China trade deal and the Fed cut interest rates three times in 2019.    

For us, the takeaway from this is clear: What happened in the markets last year does not mean much for what could happen in the markets this year. 

Put in more familiar phrasing: Past performance is not indicative of future results. 

So, while the macroeconomic environment is favorable as we begin 2020, a new year always brings new challenges and uncertainties, especially an election year.   

More specifically, as we begin 2020, we are monitoring several unknowns that, with the market at historically high valuation levels, could cause volatility in 2020.  

Regarding U.S.-China trade, markets are now wondering what’s in the phase one trade deal. The text of the agreement should be released in early-January, and while sentiment towards the deal is clearly positive, specific details remain very light. At some point, the market will demand that the details of the trade deal meet now-elevated expectations.  

Turning to the economy, markets are expecting a rebound in global economic growth. The upcoming economic data needs to continue to show signs of stabilization and, ultimately, a re-acceleration of economic growth not just in the United States, but globally.  

Looking at domestic politics, markets have ignored the impeachment of President Trump and that is not likely to change as the odds he is removed from office by the Republican-controlled Senate are very low. However, there is an election coming in November, and while many analysts do not expect it to begin to influence the markets until later this summer, we could know who the Democratic nominee is by the end of March. Depending on who that person is, it could cause unexpected volatility. Meanwhile, on the geopolitical front, we have relative calm, although tensions with North Korea and Iran are potentially rising.   

Bottom line, the fundamental outlook for the economy and asset markets has improved since the depths of the 2018 correction, and stocks have responded accordingly. It is important to realize that, despite the strong performance in 2019, markets still face significant uncertainties, and we are committed to monitoring these situations and their impact on the markets and your portfolio. 

We have been through both good and bad markets, and those experiences ensure that we guard against complacency following a year of strong annual returns. We remain committed to helping you navigate this ever-changing market environment, with a focused eye on ensuring we continue to make progress on achieving your long-term investment goals. Experience in all types of markets (both positive and negative) has taught us that successful investing remains a marathon, not a sprint.  It is critical to stay invested, remain patient, and stick to a plan. We will continue to work diligently with you to establish a personal allocation target based on your financial position, risk tolerance, and investment time horizon.

The strong market performance of 2019 notwithstanding, we remain vigilant towards risks to portfolios and the economy, and we thank you for your ongoing confidence and trust. Rest assured that we are dedicated to helping you successfully navigate this market environment.