There was no shortage of drama in 2019, a year that featured an ongoing trade war with China, continued uncertainty with Brexit, near-constant fears of slowing growth that led to an inverted yield curve, and political rancor that ended with the House issuing articles of impeachment against the President. What perhaps did not receive as much attention was that the longest expansion in US history continued, and because of the consistent economy, stocks and bonds had their best concurrent year in over two decades.
US GDP continued its solid but unspectacular rise, growing by 2.1% in the third quarter following 2.0% growth in the second quarter. The economy continues to be powered by strong consumer spending, with mixed data elsewhere. Fourth quarter GDP is widely expected to show moderate growth, meaning 2019 GDP will likely end with just over 2.0% growth for the year. At this time, most economists are forecasting a similar outlook for 2020, with slow growth, but no recession, as the prevailing expectation.
The trade dispute between the U.S. and China continued to have an outsized impact on markets during the fourth quarter. To the relief of markets, some resolution was reached, with a “Phase One” deal agreed upon between the two countries. Although relatively few details are known about the deal or when the next round of negotiations might take place, the market responded favorably to the apparent progress.
While uncertainty over the impact trade negotiations is likely to persist, there has already been a significant impact on the manufacturing sector of the economy. The widely-followed ISM survey moved to contraction territory in August for the first time in three years, and readings have remained weak since, as trade uncertainty has negatively impacted the manufacturing sector of the economy. Likewise, manufacturing readings in the Eurozone and Japan are also near their weakest levels in years as well due to trade disputes.
Beyond the headline-grabbing trade wars, other areas of the economy are showing remarkable resilience. Most notably, the strong US consumer continues to drive the economy as unemployment hovers near half-century lows. Holiday sales rose 3.4% this year according to Mastercard SpendingPulse, with online sales unsurprisingly growing much faster than in-store sales. Employers added 266,000 jobs in November and unemployment remained at 3.5%, the 21st straight month with an unemployment rate below 4.0%. In all, the strength of the US consumer appears to have kept the US economy on track despite pressures from trade and slowing global growth.
The housing market received a boost from lower rates. The NAHB/Wells Fargo housing Market Index, a measure of home builders’ confidence, reached its highest level since 1999, in part due to an average gain of 5% in home prices for the year. Additionally, November housing starts increased 3.2% over the previous month, and it appears as if 2019 will be the strongest year for housing starts since 2007.
Commodities also had a strong 2019 in most cases. WTI Crude oil gained nearly 35% for year, closing over $60/barrel following a deeper than expected production cut from OPEC members. Agricultural commodities received a bounce from the phase one trade deal, which included increases in Chinese purchases of US farm products. Metals were also broadly positive, with industrial metals such as copper benefitting from a brighter economic outlook, while precious metals rallied as well. Gold had its best year in a decade, rising nearly 20% as investors continued to keep an eye on the perceived safe havens in the markets.
With the calendar now flipped to 2020, the Democratic presidential primaries are just around the corner and have the potential to impact markets given the wide field of candidates at this time. With an upcoming Senate Impeachment Trial and of course the general elections in November, political news and noise may have an outsized impact on market returns during 2020.
The shape of the yield curve changed rather dramatically during the fourth quarter, as yields on longer-dated Treasuries ticked higher, while shorter duration bonds and T-bills dropped alongside Fed Reserve rate cuts. After a brief inversion of the 2-10 year yield curve during the third quarter, the curve closed at essentially its steepest level of 2019 with the 10-year bond yielding 35 basis points higher than the 2-year bond. The steepening of the yield curve is an important development as it suggests the bond market is far less concerned about an imminent slowdown or potential recession than it was just a few months ago.
The rise in bond yields towards year-end led to very modest bond market returns for the fourth quarter. However, the 10-year Treasury Bond finished 2019 yielding 1.92%, or more than three-quarters of a percent lower than it started the year. This of course led to a strong year in returns for the broad bond market, as bond prices move inversely with interest rates. The broadly-diversified Barclays Capital U.S. Aggregate Index gained nearly 9% for the year, its best calendar year total return since 2002. Corporate and high-yield bonds posted double- digit gains for the year, as credit spreads reached their tightest levels in nearly two years.
During its October meeting, the Federal Reserve cut interest rates by a quarter point for the third consecutive meeting, citing low inflation and fears of slowing global growth. However, the Fed signaled in its commentary that it was likely done lowering rates for the time being. The December meeting proceeded as expected, with the Fed Funds rate unchanged at its current range of 1.50%-1.75%. While the rate-cutting bias that had been exhibited in recent months appears to have ended, Fed Chair Powell seemed to set a fairly high bar for any rate hikes from this point forward, leaving an accommodative feel to the current policy. The consensus now expects rates to remain unchanged well into 2020. The next Fed meeting is scheduled for late January.
Inflation, as a whole, appears to have remained well contained. Despite a rise in headline CPI to 2.1%, the Fed does not appear overly concerned with inflation, as the personal consumption expenditures index (the Fed’s preferred metric) is still well below the 2.0% range, meaning the Fed should have the wherewithal to keep from raising rates for some time.
For the time being, the Fed appears to have avoided further turmoil in Repo markets, or markets where large investors borrow money on a short-term basis (typically overnight). These markets fell into disarray in September as rates briefly spiked, however the Fed subsequently injected liquidity and reserves into this market which has at least temporarily quelled fears in this important funding market.
Treasury yields of selected maturities for recent time periods are displayed below (data from Bloomberg).
|Treasury Bill||Treasury Notes & Bonds|
|3 mo.||2 yr.||5 yr.||10 yr.||30 yr.|
The total return numbers for various fixed income indices over the last twelve months are displayed below (data from Bloomberg).
|12-Month Returns (as of 12/31/19)|
|Barclays Capital US Aggregate||8.72%||Merrill Lunch US High-Yield||14.41%|
|Barclays Intermediate Government||5.20%||Merrill Lynch US Municipal Index||7.74%|
|Dow Jones Corporate||15.95%||JP Morgan EMBI Global||14.42%|
A strong year for stocks was capped by a year-end rally that saw all-time highs reached for the S&P 500 and NASDAQ Composite Index in late December. It was the best year for those two indices since 2013, with the S&P 500 gaining 31.5% and the NASDAQ Composite advancing 36.7% during 2019. US Small and mid-cap stocks indices were up over 25% for the year, also participating in the broad rally. International stocks once again lagged their US counterparts for the year, but still posted robust gains of 22.8% for developed markets and 18.6% for emerging markets.
Interestingly, the stock market enjoyed outsized gains in a year where earnings growth slowed sharply. In fact, earnings for 2019 are expected to finish barely positive, following greater than 20% earnings per share growth in 2018. After a sharp sell-off to end 2018, it appears that simply avoiding an “earnings recession” coupled with avoiding some of the worst-case scenarios relating to trade and the economy were enough to push the market sharply higher in 2019. The price-to-earnings ratio (P/E) now stands near 21x for the S&P 500, compared to roughly 16x at the end of 2018.
By one measure, gains were broad-based, with approximately 90% of the stocks in the S&P 500 rising during 2019. However, a handful of big technology stocks did much of the heavy lifting, as the technology sector alone accounted for about one-third of the market’s gains. In fact, Apple and Microsoft both ended the year with market values over $1 trillion and the two giants accounted for nearly half of the technology sector’s gain.
Looking at the fourth quarter, 2019’s rally picked up steam into year-end, with the S&P 500 gaining over 9% during the period fueled by renewed optimism on trade talks as well as timely interest rate cuts by the Fed. While domestic large cap stocks were the biggest winners in 2019, there were some return benefits from diversification later in the year, as US small-cap stocks and Emerging Market stocks outperformed the S&P 500 during the final quarter of 2019.
The fourth quarter’s rally was broad-based, with a rally across nearly all equity markets. The S&P Value index slightly outperformed the corresponding Growth Index as stocks with relatively less expensive valuations fully participated in the rally. Growth stocks were certainly not left behind however, as the tech-laden NASDAQ Composite led widely-followed indices with a 12.5% return, nearly doubling the return on the Dow Jones Industrial Average for the quarter. International stocks bounced higher in the quarter as well despite pockets of weak international data. The progress in US/China trade talks undoubtedly had a positive effect on the outlook for international stocks.
As we closed the year on a high note, investors will continue to dissect mixed economic reports in lockstep with grandiose political headlines. For now, analysts expect companies to generate 9-10% earnings growth in 2020, and with markets near all-time highs, these increased profits will likely be necessary to maintain the rally.
|Equity Indices||4th Quarter 2019|
|Dow Jones Industrial||6.67%|
|S&P 500 Growth||8.32%|
|S&P 500 Value||9.92%|
|Russell 2000 (small-cap)||9.93%|
|MSCI/EAFE (developed international)||8.23%|
|MSCI/EM (emerging markets)||11.74%|
Technology stocks continued to perform exceptionally well during the quarter, and were easily the best performing sector of 2019, with a gain for the sector of just over 50% for the year. After lagging the market for much of 2019, Health Care stocks were also a top performing sector for the fourth quarter, primarily due to a relief rally as support for a “Medicare for All” plan appeared to wane. Financial stocks also posted a double-digit gain for the quarter, buoyed by a steepening of the yield curve.
Interest rate sensitive sectors including Real Estate and Utilities were the poorest performing sectors for the quarter in part due to higher rates, but also reversing course from the prior period as the broad market rallied in the fourth quarter. Despite a rise in crude oil and commodity prices, Energy and Materials sectors also lagged the broad market for the quarter and the year.
|Return by Stock Sector||4th Quarter 2019|
|1. Information Technology||14.40%|
|2. Health Care||14.37%|
|4. Communication Services||9.00%|
|8. Consumer Discretionary||4.47%|
|9. Consumer Staples||3.51%|
|11. Real Estate||-0.54%|
The Investment Overview is published quarterly by the Union Investment Management Group of Union Bank & Trust Company. Please address correspondence to: Union Bank & Trust, Attn: UIMG, PO Box 82535, Lincoln, NE 68501-2535.