As we turn the page to 2020, many of the positive developments that recently underpinned financial markets remain
Anticipate a return to more normal levels of market volatility typical of the later stages of the bull market
Our base case for the U.S. economy in 2020 continues to be slowing but sustainable growth
We continue to believe the best course of action is to build resilient portfolios of high-quality, durable assets
Even those with the rosiest of glasses would have been hard pressed to foresee 2019’s market performance. Dovish shifts from world central banks and progress in U.S.-China trade negotiations helped ease early-year investor concerns and propelled financial markets to outsized gains. The S&P 500 finished up 31.5%, the best annual performance in half a decade, with many major global indices also ending the year at or near record highs. Meanwhile, falling interest rates and declining credit spreads boosted returns on a wide range of fixed income asset classes.
As we turn the page to 2020, many of the positive developments that recently underpinned financial markets remain, including sustainable economic growth, benign inflation, and low interest rates. This leaves the stage set for further worthwhile gains in equity markets and select credit opportunities in fixed income. However, we advise clients to lower their expectations for portfolios going forward.
Although the ebbing of near-term recession concerns argues for staying invested in stocks, slower economic and low corporate profit growth mean returns should be more modest. Ongoing policy uncertainty and elevated geopolitical risks will also remain headwinds, particularly as the election season heats up, and anticipate a return to more normal levels of market volatility typical of the later stages of the bull market.
Our base case for the U.S. economy in 2020 continues to be slowing but sustainable growth, buttressed by a healthy household sector, and supports our continuing preference for U.S. equities. Overseas, economic growth remains more challenging. Though we expect the global economy to bottom out around the first quarter, the pace of this recovery will be relatively slow and spread unevenly across regions, with developed economies in particular still struggling against long-term structural headwinds.
The emergence of a limited trade agreement between the U.S. and China has helped drive the rally in stocks, easing fears of further escalation. Still, we caution against reading too much into the recent optimism. Consumer and business optimism wobbled last year not only due to direct costs of tariffs, but as a result of the unpredictable nature of the trade environment. The “Phase I” deal is clearly a step in the right direction, but we suspect most of the benefits have now been priced into the market, and as long as core issues remain unaddressed, uncertainty will likely continue to weigh over the outlook.
When looking back on 2019, the old market adage “don’t fight the Fed” has never been truer. Collectively, global central banks enacted 129 separate rate cuts last year. This synchronized policy easing was a key driver of financial markets, contributing to the fall in short- and long-term interest rates and benefiting equities and bond prices. Easier financial conditions will likely continue to support stock prices next year, but the central-bank stimuli and interest rate cuts that drove returns last year are unlikely to be repeated in 2020.
Now that the pendulum of investor sentiment appears to have swung back to a more optimistic position, we don’t anticipate the recent rally or reduction in volatility to continue indefinitely. Even the best markets need to catch their breath from time to time, and a consolidation period or another pullback wouldn’t be surprising in the months ahead.
Similarly, for fixed income investors, we expect returns to be in line with the current income offered on bonds, while price gains are likely to be limited. From current levels, yields are likely to move modestly higher, while there isn’t much room for credit spreads to fall further. Though we believe there are still spots clients can earn a relatively safe and above market yield, we look to collect coupons in credit instruments and are staying higher in quality, even if that means giving up some yield, as corporate credit looks priced for perfection.
Hindsight may be 20/20, but foresight isn’t, and although we continue to believe that there are rewards ahead for investors, there are also dangers. Our late-cycle playbook has served us well through the many highs and lows of the past two years, and we continue to believe the best course of action is to build resilient portfolios of high-quality, durable assets. By keeping our focus on dividend paying U.S. stocks, select credit areas, and alternatives, we have positioned our portfolios to help withstand late-cycle volatility and minimize risk, yet continue to participate in ongoing gains.