What a difference a year makes! In stark contrast to the story of 2018, returns across almost all asset classes were universally positive in 2019. While strong returns early in the year were a makeup for the dismal fourth quarter of 2018, market activity in the last quarter of the year was an unambiguous scramble for returns. The success of the Federal Reserve’s (Fed) mid-cycle adjustment convinced investors that they could have their cake and eat it too in the form of lower rates and strong stock returns.
The Standard and Poor’s 500 (S&P 500®), a broad measure of U.S. stock market performance, struggled to sustain new highs during the second and third quarters of the year. The fourth quarter marked a definite breakout as the S&P 500® gained over 8% and finished the year with a total return of over 30%. Bonds delivered a strong performance as well. Even commodities joined the party (after lagging for several years), providing a gain of over 11% for the year.
The big question on investors’ minds is whether this year’s extraordinary returns are
justified or if we’ve pulled future returns forward. The Fed’s “insurance” rate cuts appeared effective in stimulating the markets. The Treasury yield curve, which inverted briefly during the year (potentially signaling recession), regained its typical positive slope as short term rates followed the decline in the federal funds rate (the interest rate set by the Fed) and longer rates rose during the quarter. We believe the market is pricing in a Goldilocks economy where both growth and inflation are just right. Adding to the euphoria, rhetoric around Brexit and trade has become positive, calming markets in the near term.
While we can identify many strengths, real risks remain. Reaching a trade deal with China is good, but it’s unlikely to produce steadily expanding global economies. Labor markets are tight as the unemployment rate remains at a historic low of 3.5% (as of November 2019).
Wage growth continued to inch up to 3.7% in November 2019, approaching the 50-year average of 4.0%. An increase in wage growth can be a precursor to inflation as more consumer spending can lead to prices increasing throughout the economy. Corporations have taken advantage of low interest rates by adding debt to their balance sheets, and corporate margins peaked in 2018. Populism remains on the rise, and political risk is a real concern as we approach the November election. Election years are known for their volatility. Late cycle GDP (Gross Domestic Product, a measure of all the finished goods and services produced within a country’s borders) growth of around 2% is good but provides little room
for error. The Fed’s three rate cuts in 2019 used dry powder, increasing concerns about how policymakers will counter the next downturn. In addition, stretched valuations have the market primed for increased volatility.
Election years tend to exhibit increased volatility as the stocks seek to find their way through the uncertainty of a new President. Adding to the concern for this year is a market priced for perfection. We could be entering a “straw that broke the camel’s back” year in which a seemingly minor hiccup could send the market into a large and sudden reaction.
These actions are impossible to time. The defense is a balanced portfolio designed to address your specific needs. Now is a good time to rebalance as the meteoric rise in stocks this year can leave portfolios with more risk than initially intended. As always, we are happy to discuss these or any other topics. Happy New Year!
The views and opinions expressed are of Persium Advisors, LLC. This commentary is provided for educational purposes only and should not be construed as investment advice. Persium Advisors is an investment advisor firm located in Atlanta, GA.
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