The following are excerpts from our Fourth Quarter/Year-End 2019 Letter to Clients. If you would like to read the whole letter or be added to our distribution list, please email firstname.lastname@example.org.
Q4 & 2019 Year-End Recap
2019 ended pretty much the way it started, with a robust market across a variety of asset classes. Equities were higher, the corporate credit environment remained healthy, and while rates were modestly higher it was not enough to cause bond investment losses on a total return basis.
What Worked in 2019?
Since the year is out, it is worth reviewing 2019 in its entirety. Some types of equity investments outperformed others, but the full year story is very similar: everything worked. This includes conservative bond investments, as falling rates confounded forecasters and led to bond price appreciation.
As you can see, the leader was clearly the S&P 500, which posted its best annual return since 2013. Dispersion of returns was very wide, and the more investors diversified away from large cap US stocks, the less robust the results were and materially so.
2019 Recap & The Stark Contrast to 2018
As we entered the year, the outlook was quite bleak. Most economists had forecasted rates to rise and the Fed to keep tightening. Many commentators were quite bearish on the global economy and corporate profits. The yield curve flattened, then inverted, and later normalized. The Fed went from forecasting a couple of hikes this year, to forecasting no hikes at all, before eventually cutting rates three times before year-end. This is to say nothing of the dysfunction in Washington and the geopolitical tensions.
Against this backdrop the market climbed a wall of worry. Apart from two difficult months, May and August, the market looked healthy and relatively strong all year.
With the benefit of perfect hindsight, we can say that by the end of 2018, taking risk seemed to be imprudent. By the end of 2019, it was avoiding risk that seemed to be imprudent. We try not to let recent results color what we think is prudent now.
Any comments on the upcoming year should be caveated by pointing out how badly so many forecasters missed on 2019 predictions. With that said, let’s take a prospective look at 2020.
When we look ahead, we believe it is helpful to distinguish between what we think and what we know.
We know the rally in 2019 was not supported by earnings growth, as corporate earnings were essentially flat. Most of the gain was simply the result of investors putting a higher price on the earnings stream. We think that was because investors were feeling better about the environment, the Fed’s accommodation, and the prospect for earnings growth in 2020.
We know right now Wall Street consensus is for earnings to grow mid to high single digit in 2020. We also know that the consensus tends to be most optimistic around the New Year and those estimates tend to come down throughout the year. We think given the elevated valuation, companies will need to deliver on those expectations for the market to move higher, and we don’t think this year’s performance is repeatable in 2020.
We know that rates are historically low. We think there are good reasons for that and the risk to rates remains to the downside. We also think the amount of debt out there in the developed world is an overhang that creates an environment of lower highs and lower lows in rates.
We know that 2020 is a Presidential election year in the US. We think the economy should favor the incumbent, but we also note that this is an unusual incumbent. Regardless of the outcome, we know that roughly half the country will be upset. The outcome for markets depends on a number of variables and just knowing who sits in the White House may not be enough information to make an accurate prediction about the market. We are reminded of this Bloomberg article from the last election, which profiled an investor who called the election outcome but ultimately whiffed on the market outcome.
We know 2019 was a year with below average volatility and above average returns. We think base expectations should be for higher volatility and lower returns in 2020.
Best wishes for a healthy and prosperous New Year!