Geopolitical risks that dominated the news cycle for much of 2019 subsided a bit during the year’s final quarter. Trade policy uncertainty, in particular, faded with the announced phase one trade deal between the U.S. and China. And in the UK, near-term political uncertainty fell following the Conservative Party’s landslide general election victory. The fourth quarter also saw the Federal Reserve’s third rate cut of 2019 followed by a statement indicating that "the current stance of monetary policy is appropriate." No further rate cuts are expected in 2020. U.S. equities generated strong gains in the fourth quarter driven by an improved economic picture, somewhat alleviated trade tensions, and a dovish Fed.
Developed international equity returns for the quarter were strong (8.17%), but trailed those generated in the U.S (9.10%). European equities gained nearly 9% during the period. European stocks were supported by the trade deal between the U.S. and China as well as better economic data from Germany. In Japan, equity markets lagged broader international indexes but still produced a solid gain of more than 7%. Significant Japanese economic developments included the consumption tax increase on October 1st and announced greater planned fiscal stimulus. Emerging markets, which produced a gain of nearly 12%, showed particular strength during the fourth quarter as geopolitical risks eased. China, the index’s largest constituent, rose nearly 15% as markets reacted positively to the U.S.-China trade agreement.
Fixed income markets were positive for the quarter. Government bond yields rose as sentiment improved and investors sought risk. The U.S. 10-year Treasury yield increased 26 bps while the two-year yield dropped five bps. The steepening yield curve reflected a more optimistic view of the economy. Overseas, the 10-year German bond jumped 38 bps and finished the quarter at a negative 0.19%. The 10-year UK gilt yield increased 33 bps amid optimism surrounding Brexit. U.S. corporate bonds outperformed government issues, and high yield bonds continued to produce strong results, returning more than 14% for the year. Finally, emerging markets delivered solid fixed income results. Local currency emerging market bonds did especially well as EM currencies showed strength in December.
A year ago, markets were nervous. Today, central bank easing, the apparent de-escalation of trade disputes, and generally encouraging economic data have pushed global stock markets higher, with U.S. equities reaching new all-time highs by the end of 2019. Significant uncertainties remain, however, including the potential re-escalation of trade conflicts, a shift in central bank policies, the agenda of the occupant of the White House in 2021, and other geopolitical risks including unrest in Hong Kong and actions by Iran. All things considered, the outlook for 2020 is one of cautious optimism.
In the U.S., markets should enjoy tailwinds in the form of 2019’s three Fed rate cuts and improving business sentiment. The fading effect of the 2017 tax cuts and uncertainty about future tariff policy, however, offer potential headwinds. Political uncertainty associated with the November 2020 election is likely to hamper plans by businesses to expand capacity until further clarity on the likely direction of future policies and may generate volatility given the wide range of possible policy outcomes. Given the maturing economic cycle, many geopolitical uncertainties, and richer current valuations, an emphasis on quality holdings with durable profit streams and reliable dividends may prove propitious.
International developed equity markets sharply lagged their U.S. counterparts in 2019. Going forward, international stocks are expected to produce returns more in line with U.S. stocks, thanks to more reasonable valuations. Notably, international stocks tend to be more economically sensitive than U.S. stocks. Therefore, should global growth re-accelerate, international stocks may offer greater upside potential. To take advantage of diversification benefits as well as currently attractive valuations, investors with a significant below benchmark allocation to international equities may want to consider increasing their exposure.
Emerging markets continue to face uncertainties stemming from the U.S.-China trade conflict, softening economic growth in China, and other global challenges that are likely to persist. Emerging market economic growth is expected to be strong but muted by ongoing difficulties for companies and economies sensitive to weakness in global manufacturing. On a positive note, valuations are attractive and central bank policies outside of China are likely to remain supportive. Finally, moderate U.S. dollar weakness wouldn’t be unexpected, and emerging market stocks should benefit from relative local currency appreciation. In short, some exposure to this asset class is certainly appropriate, but the shorter-term risks suggest that caution is prudent.
Rates across the yield curve remain near historically low levels. With greater rate stability expected from the Fed, investors are unlikely to benefit from falling yields in 2020 to the same degree they did in 2019. Within credit markets, investment grade bonds currently appear attractive relative to high yield debt where valuations appear stretched. Returns for international bonds in 2020 may be marginally lower than those for U.S. bonds given the relatively lower yields currently offered in non-U.S. developed markets. Municipal securities remain a viable option for investors in higher tax brackets, however, limited supply and strong demand have pushed valuations higher; a condition expected to continue. Overall, while fixed income returns are expected to be low in the near-term, client portfolios should still maintain exposure to higher-quality bonds for diversification and to provide ballast in case of equity volatility.
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Based on historical S&P 500 trailing twelve-month Price-to-Earnings (P/E) ratios, our gauge of U.S. equity valuation registers a reading in the 13th percentile relative to historical month-end P/E ratios from 1957 - 12/31/2019.
Based on Federal Reserve Bank of Philadelphia’s U.S. Coincident Index, our gauge of U.S. economic activity registers a reading in the 55th percentile relative to quarter over quarter change of the Coincident Index from 1979 - 12/31/2019.
This economic and market commentary was prepared by Capital Market Consultants, Inc. (CMC), an independent investment management consulting firm, and has been approved for distribution by GW & Wade, LLC. Data used to prepare this report by CMC are derived from a variety of sources believed to be reliable including well established information and data software providers and governmental sources. CMC is not affiliated with any of these sources.
The information provided above is general in nature and is not intended to represent specific investment or professional advice. No client or prospective client should assume that the above information serves as the receipt of, or a substitute for, personalized individual advice from GW & Wade, LLC, which can only be provided through a formal advisory relationship.
About the indices presented above:
- Standard & Poor's 500 (S&P 500®) Index is a market capitalization–weighted index of 500 common stocks chosen for market size, liquidity, and industry group representation to represent U.S. equity performance.
- The Dow Jones Industrial Average (DJIA) is a price-weighted average of 30 significant stocks traded on the New York Stock Exchange (NYSE) and the Nasdaq.
- The Russell 2000 Index measures the performance of the small-cap segment of the U.S. equity universe. It includes approximately 2,000 of the smallest securities based on a combination of their market cap and current index membership.
- The MSCI ACWI (All Country World Index) is a market capitalization weighted index designed to provide a broad measure of equity-market performance throughout the world.
- The MSCI EAFE Index is an equity index which captures large and mid cap representation across Developed Markets countries around the world, excluding the US and Canada.
- The MSCI Emerging Markets Index (EM) captures large and mid cap representation across 24 Emerging Markets (EM) countries.
- The Bloomberg Barclays Global Aggregate Bond Index measures global investment grade debt from twenty-four local currency markets. This multi-currency benchmark includes treasury, government-related, corporate and securitized fixed-rate bonds from both developed and emerging markets issuers.
- The Bloomberg Barclays US Aggregate Bond Index measures the performance of the U.S. investment grade bond market. The index invests in a wide spectrum of public, investment-grade, taxable, fixed income securities in the United States – including government, corporate, and international dollar-denominated bonds, as well as mortgage-backed and asset-backed securities, all with maturities of more than 1 year.
- The Bloomberg Barclays US Credit Index measures the investment grade, US dollar-denominated, fixed-rate, taxable corporate and government related bond markets. It is composed of the US Corporate Index and a non-corporate component that includes foreign agencies, sovereigns, supranationals and local authorities.
- The Bloomberg Barclays US Corporate High Yield Bond Index measures the USD-denominated, high yield, fixed-rate corporate bond market. Securities are classified as high yield if the middle rating of Moody's, Fitch and S&P is Ba1/BB+/BB+ or below. Bonds from issuers with an emerging markets country of risk, based on Barclays EM country definition, are excluded.
Views expressed are as of the date indicated, based on the information available at that time, and may change based on market or other conditions. GW & Wade assumes no duty to update any of the information presented above.
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