Equity markets around the globe delivered very strong results in the fourth quarter of 2019. The S&P 500 Index generated total returns of 9.1% for the fourth quarter and 31.5% for the entire year. The year closed out one of the best decades on record for U.S. stock performance. The S&P 500 produced annualized total returns of 13.6% for the decade.
The decade began in a period of significant crisis. The global financial system was on the brink of failure and economies around the world were struggling to recover from the worst global recession since the Great Depression. While the U.S. economy has been slow to rebound compared to prior business cycles, the 2010s are the only decade on record that did not experience a recession. The economic expansion began in July 2009 and continues today. It is the longest recorded expansion in U.S. history, but has been characterized by the slowest rate of growth since World War II.
A significant part of 2019 equity returns can be attributed to a recovery from a steep correction which occurred in late 2018. At the time, most major stock indices had declined 20% or more from their highs on fears that the global economy could slip into a recession. The trade war with China and a series of interest rate increases by the Federal Reserve were fueling investors’ concerns. But as 2019 progressed, the recessionary worries abated as the Fed lowered interest rates and trade tensions subsided.
The table below shows the performance of major equity indices for selected time periods.
Equity Performance for Periods Ending on December 31, 2019
|Total Return Index||Market Sector||Quarter||1-year||3-year||5-year||10-year||15-year|
|S&P 500||Large U.S. Companies||9.1%||31.5%||15.3%||11.7%||13.6%||9.0%|
|Russell 2000||Small U.S. Companies||9.9%||25.5%||8.6%||8.2%||11.8%||7.9%|
|MSCI EAFE||Developed Int’l Markets||8.2%||22.0%||9.6%||5.7%||5.5%||4.8%|
|MSCI EM||Emerging Int’l Markets||11.8%||18.4%||11.6%||5.6%||3.7%||7.5%|
At the beginning of the year, the Federal Reserve signaled that it would implement two more interest rate increases as part of its strategy to normalize interest rates (after almost 10 years of suppressing rates to help stimulate economic growth). However, the Fed ended up changing course. It backed off its plan to increase rates and, instead, suggested it would consider lowering rates if necessary. While trying to remain independent, the Fed was under pressure from the Trump Administration to lower rates to continue to fuel the economy. In changing its policy, the Fed stated it was taking into account the negative impact of trade tensions as well as slowing foreign economies. The Fed eventually followed through with three interest rate cuts in the second half of 2019. This change in Fed policy is credited with contributing significantly to the stock market’s strong 2019 performance.
Progress made on trade policy also contributed to end-of-year stock market performance. While trade negotiations with China stalled several times during the year, substantial progress was made in the fourth quarter. A Phase 1 trade deal was reached in December which will lower U.S. tariffs on Chinese imports and increase China’s purchases of U.S. agricultural, energy, and manufactured products. And in December, the U.S., Canada, and Mexico signed a trade agreement which will replace NAFTA. Though signed, the deal will not take effect until it is ratified by the U.S. Senate, expected to occur early this year. The easing of these two trade tensions helped to reduce the cloud of uncertainty hanging over corporations for the past two years and provided additional optimism for investors.
With the strong performance of equity markets in 2019, stocks are now priced at moderately high valuations relative to their future earnings. The S&P 500 Index is now trading at a price-to-earnings (P/E) ratio of 18.3 based on next 12-months estimated earnings. This P/E ratio compares to the five-year and ten-year averages of 16.6 and 14.9, respectively. This higher valuation reflects that investors are expecting strong future earnings growth, low interest rates, and no recession in the near term. The combined earnings of S&P 500 companies are forecast to grow 9.6% in 2020, which if achieved, should support moderately higher stock prices.
While the stock market environment generally looks constructive, we note that there are plenty of risks which could materialize and threaten equity performance. A slowing economy, reduced consumer spending, or disappointing earnings growth would have negative consequences. Implementation problems related to Phase 1 of the China trade agreement, or a lack of progress on Phase 2 negotiations (especially on intellectual property issues) would likely concern the markets. The results of the impeachment trial in the Senate and the outcome of next year’s presidential election could significantly impact markets and specific sectors.
As previously noted, the Federal Reserve entered 2019 with the intention of increasing interest rates, but soon reversed its stance, and ultimately executed a series of rate cuts. In late October, the Fed cut its benchmark interest rate by a quarter of a percent to a target range of 1.50% to 1.75%. It was the third cut in four months. Long-term interest rates, which are primarily dictated by market forces, declined in 2019. The yield on the 10-year Treasury Bond ended 2019 at 1.92%, compared to 3.05% at the beginning of the year. The Bloomberg Barclays Aggregate Bond Index generated total returns of 0.2% and 8.7%, respectively, for the fourth quarter and full year. Because longer duration bonds would suffer a significant loss if interest rates increase to more normalized levels, we continue to maintain a relatively short-term average maturity for the fixed income investments in our managed portfolios in order to minimize this risk.
As a side note, we would like to comment on several major news events impacting TD Ameritrade, which is the broker and custodian for most of the client assets we manage. In early October, TD Ameritrade quickly followed Charles Schwab’s action to cut equity trading commissions to zero on most stocks and exchange traded funds. Although commissions were already relatively low, the elimination of trading costs can only be viewed as positive for our clients.
In late November, Charles Schwab announced an agreement to acquire TD Ameritrade. The boards of both companies have approved the transaction, which is expected to close in the second half of 2020, pending regulatory approval. The integration of the two firms is expected to take 18 to 36 months following the deal’s closing. Both companies have excellent track records that extend back more than 40 years and provide outstanding service to independent investment advisers and their clients. We anticipate no major changes in the immediate future for accounts held at TD Ameritrade and ultimately expect a smooth integration.
As we look forward to a new decade, we remain optimistic that equity investments will continue to deliver attractive long-term returns, most likely exceeding those of the other major asset classes. After all, companies are in business to create value for shareholders. Fixed income investments are likely to produce only modest returns, but provide a ballast against the unpredictable nature of the stock market. We believe that maintaining an appropriate asset allocation between equity and fixed income investments is the primary means for helping clients achieve their long-term goals while accepting tolerable levels of risk.
We wish you the best for 2020.
John D. Frankola, CFA Lawrence E. Eakin, Jr. Matthew J. Viverette
Vista Investment Management, LLC is a Registered Investment Advisory firm. Under no circumstances does this article represent a recommendation to buy or sell stocks. This article is intended to provide information and analysis regarding investments and is not a solicitation of any kind. References to historical market data are intended for informational purposes; past performance cannot be considered a guarantee of future performance. Neither the author nor Vista Investment Management, LLC has undertaken any responsibility to update any portion of this article in response to events which may transpire subsequent to its original publication date.