Strong 4th quarter returns helped the major stock indices reach all-time highs in late December as the markets delivered the strongest annual returns since 2013. For 2019, the benchmark S&P 500 posted 28% price appreciation. The Fed delivered a third 0.25% rate cut in October to provide additional cushion against international economic weakness, culminating a mid-cycle policy adjustment. The U.S. and China reached terms on a Phase One trade agreement which may dampen trade worries that pressured market sentiment at several points during the year. Both the expected Fed move and the trade progress helped boost markets during the quarter. The U.S. economy continues to post solid job growth, as unemployment remains near a 50-year low of 3.5%. The strong stock market and employment situation are helping support consumer confidence and spending. As 2020 begins, the Fed feels the three rate cuts over the second half of last year should be sufficient to maintain economic momentum for the time being. Policy makers will assess incoming data to determine if any adjustments are warranted.
Views on where the U.S. economy is in the business cycle have shifted as the longest expansion on record continues. Earlier in 2019, longer-term bond yields fell below yields on shorter maturity bonds. This “inversion” typically occurs in the late cycle stage and can signal a future slowdown. Yields have returned to a more normal relationship where investors earn higher yields on longer maturity bonds. That change – due in part to the Fed’s rate cuts – has perhaps put the economy back into mid-cycle status where solid, though unspectacular, growth could continue for several more years. On another positive note, financial imbalances or uncomfortably high inflation that have historically appeared in the late cycle stage do not currently seem visible. When inflation is elevated, Fed rate hikes needed to keep prices more tame also dampen economic growth. Global growth has been lackluster, as trade concerns and the ongoing Brexit discussions have led businesses the world over to be more cautious. This caution has definitely showed up in manufacturing data and business surveys.
Compared to the previous three months, stock market volatility was quite tame during the 4th quarter. Earnings reports were slightly better than expected overall, though estimates had been lowered to recognize global trade headwinds. After a 2018 earnings surge due in part to lower corporate tax rates, firms have faced a challenge to top those earnings in 2019. As stock prices track earning power over the long-term, it’s encouraging to note that earnings are projected to grow at a faster rate in 2020. Most sectors posted price appreciation well over 20% for 2019, with Information Technology leading the way up 48%. Communication Services (+30%) & Financials (+29%) both topped the overall S&P 500 return. Energy (+7%) continued to lag. Healthcare (+18%) posted a strong 4th quarter (+13%), as some of the more extreme proposals from the campaign trail seem less likely to become policy.
A Phase One trade agreement easing the tariff battle between the U.S. and China helps ease some geopolitical fears that rattled the markets during 2019, and sets a more positive trade backdrop for 2020. Slowing Chinese economic growth probably helped that agreement happen. Economic reports early in the new year have been positive. The U.S. presidential election cycle does present potential volatility as the market assesses candidate policy proposals, but current forecasts point toward a continued split government, with each major party controlling at least the presidency, the House or the Senate. Such a split limits the potential for dramatic policy moves. While market expectations for 2020 returns should probably be more modest than those witnessed in 2019, average S&P 500 price appreciation for the past two years is roughly 10%. As ever, staying the course with a balanced and diversified portfolio should provide attractive returns over the long run.