“It’s time, not timing, that makes money in the market.” – Anonymous
Review
The stock market rewarded investors with phenomenal gains in 2019 defying many of the market pundits. The S&P 500 Index rose 31.5% for the year, which marked its best annual return since 2013. Likewise, the Dow Jones Industrial Average returned 25.3% and the NASDAQ Composite advanced 36.7%. International stocks were a bit weaker than domestic markets, but also posted strong advances as measured by developed market and emerging market annual returns of 22.7% and 18.9%, respectively.
The S&P 500 finished 2019 with a flourish, notching gains in 11 of the year’s final 12 full weeks. Impressively, all eleven S&P sectors were positive for the year. Technology, communication services and financials were the best performing sectors. Materials and healthcare lagged the broader market, while energy produced the smallest annual gain of any sector.
We all likely recall the negative stock market returns in the 4th quarter of 2018. During that period, we saw (1) the global economy weakening, (2) stocks, bonds, and commodities prices falling, and (3) broad concern that the Federal Reserve raising interest rates would tip the economy into a recession. As a result, many investors began 2019 with trepidation over their exposure to the stock market. The just completed year in the stock market is a prime example of why it is impossible to accurately time when to be in or out of the stock market.
According to a study by Putnam investments, an investor who stayed fully invested in the S&P 500 over the 15-year period ending 12/31/18 would have experienced a 7.77% annualized total return. However, if that same investor missed just the 10 best days in the market over that period, the annualized return would have dropped to 2.96%. That type of return is more in line with what an investor might expect from bond investing, not stock market investing. Furthermore, if the unfortunate investor had missed the 20 best days, the effective return over the period would have been zero.
The overall positive stock market returns have occurred despite a modest Gross Domestic Product (GDP) growth rate of 1.9% in the third quarter of 2019, which followed a 2% rise in the second quarter. GDP is expected to be around 2% for the fourth quarter of 2019, and 2%-2.25% for the full year 2020. The US economy has managed to post positive economic growth despite the negative effects of the trade war, global economic weakness, a treasury bond yield curve inversion earlier in 2019 and the impeachment articles brought in the US House of Representatives.
Throughout most the past year, many economists were projecting an economic recession in 2020, but more recently have shifted their recession forecast out to 2021. It is difficult for us to see the necessary ingredients of an impending recession as the economy is currently experiencing a goldilocks scenario of (1) moderate economic growth, (2) a strong labor market with historically low unemployment, (3) low interest rates, (4) tame levels of inflation, and (5) the stock market at all-time highs.
The Federal Reserve Bank reduced the Federal Funds rate in July, September, and October, each time by 25 bps or one quarter of one percent. This set the overnight lending rate in a range of 1.50% to 1.75%. The Central Bank’s dovish moves were largely in response to slowing economic conditions around the globe and aimed at countering the dampening effects of trade tensions. Most officials at the Federal Reserve think interest rates are now low enough to maintain positive economic growth for the foreseeable future. If their favorable economic forecast holds true, most expect the Federal Reserve will leave rates unchanged throughout 2020.
Outlook
S&P Capital IQ expects the broad economic growth rate to improve in 2020 along with an increase in corporate profits. They forecast the S&P 500 companies to record an 8.2% increase in earnings per share in 2020. Based on these expectations, the forward price-to-earnings ratio for the S&P 500 is 18x versus the long-term average of 16.4x since 2000. Therefore, we believe stock market valuation levels are still reasonable even after the out-sized stock market gains of 2019.
In the United States, manufacturing and export activity continued to grow modestly with spillover weakness from the trade war not as dire as initially forecasted.The consumer continues to be the backbone of the economy and stock market.Consumption, which accounts for more than two-thirds of the American economy, remains very healthy.This is largely a result of a 3.5% unemployment rate, according to the U.S. Bureau of Labor Statistics, accompanied by recent solid wage growth.
According to CFRA equity research, there are several encouraging factors for the stock market in 2020. First, 2020 is a presidential election year. Since World War II, the S&P 500 has risen an average of 6.3% in price during the fourth year of a Presidential term, with the stock market posting a positive return 78% of the time. Second, the Federal Reserve remains in an accommodative mode. During the previous 16 rate cutting cycles since WWII, the S&P 500 gained an average of 18.6% in the 18 months after the initial rate cut, and 75% of the time gained in price. Finally, the attractiveness of bonds relative to equities continues to be muted since the dividend yield on the S&P 500 remains near or above the yield of the 10-year US Treasury Note.
Not surprisingly, there are potential events lurking that can bring volatility to the economy and financial markets.As we begin the new year possible negative headwinds could arise from ongoing conflict with Iran, trade tensions with China, a potentially slowing economy in Britain as they finally exit the European Union, and political uncertainty leading up to the US elections in November. We remain flexible to the need to adjust portfolios as significant events unfold.
Our base case outlook is for the US economy to remain on a steady growth path, inflation to stay under control, interest rates to remain accommodative, corporate profits to continue an upward trajectory, and trade tensions with China to subside. In line with our last quarterly review, we still believe the positives outweigh the negatives. Therefore, we maintain a constructive view of the stock market for the year ahead.
Sincerely,
Marietta Wealth Management, LLC