Investment Review and Outlook – January 2020
Performance across most financial assets was overwhelmingly positive in 2019. Due to the breadth of market success, we might call it a “rising tide that lifts all boats” scenario. We do not expect this type of banner year to occur with any regular frequency, so our expectation for future performance is much more tempered.
We do believe, however, that risk assets (stocks) could have another good year in 2020, with some of the recent headwinds shifting to tailwinds. Our rationale for this is that:
- Global trade will normalize in 2020 with the cessation of the trade war, boosting business confidence and therefore global growth,
- Consumers remain financially strong and seemingly willing to spend given record-low unemployment, and
- The Fed remains committed to supporting the economy, with their interest rate policy seemingly steady for the foreseeable future.
Despite our hopeful outlook, we understand that there are pitfalls that could just as easily surprise on the downside. This is especially true for political/geopolitical risks and the recently unfolding health and economic risks surrounding the coronavirus. We remain humble about our ability to predict the future. We do not know which way markets will move next, but we do know that our experience gives us calmness to see opportunity in asset mis-pricings and to execute on our strategy that seeks to maximize return (after all investment costs and taxes) per unit of risk taken.
Markets and Economy
Monetary authorities in the U.S. and elsewhere put forth a number of policy adjustments in 2019, including three consecutive Fed interest rate cuts that have the potential to improve growth. In the eyes of the market, the combination of multiple interest rate cuts, a material expansion in the Fed’s balance sheet, and an improvement in U.S.-China trade relations may be sufficient to keep the U.S. expansion on track. The means and scope by which the Fed seeks to cushion the U.S. economy during the next economic downturn though, with a sub-2% federal funds rate and a balance sheet nearly 20% the size of the overall economy, may prove to be one of the most pivotal factors asset allocators face over the cyclical horizon.
After a year of surprising market performance (recall the economic doom and gloom at the end of 2018), investors should remember to exhibit caution regarding forecasts. Investors often look at market consensus, or the aggregate predictions of all market participants, as a reasonable predictor of future market moves. The belief here is that individuals are often wrong, but the average of their guesses should trend towards a reasonable estimate. While this sounds like a sensible method, the chart below proves that not even the market’s collective conscious can consistently predict the future.
At the beginning of the year, analysts overwhelmingly predicted a yield increase in the 10-year U.S. Treasury. What the market did not account for, and had no way of knowing would happen, was the Fed’s dovish reversal on interest rate policy. By recommitting the central bank to accommodation, which resulted in three interest rate cuts in 2019, the Fed sparked a precipitous drop in Treasury yields. There is no way to know what will happen in the future, despite the plethora of methodologies that claim insight. The best way to insulate against future shocks is through broad diversification and a portfolio that aligns with your individual risk tolerance.
To recap, in the last quarter of 2019:
- 10-Year U.S. Treasury yields increased from 1.7% to 1.9%; while
- Global stocks (as measured by the MSCI ACWI benchmark) increased 9%; while
- Emerging Market stocks led the way, up 12%; and
- Diversifying Strategies were up 3%, rounding out a strong year with approximately 7% returns.