It seems far-fetched, but if you can remember all the way back to late December 2018, things looked markedly different than they do today.
Investors came into 2019, expecting the very high levels of volatility that existed in the fourth quarter of 2018 to continue. From mid-September 2018 through late-December 2018, the S&P 500 dropped more than 20% (on an intraday basis). On a closing day basis, it was closer to 19.8%, thereby avoiding the dreaded “bear market” territory moniker.
The 20% threshold is an arbitrary number assigned to denote a bear market, but alas…that is a conversation for another day. Anyhow, if you still don’t remember what it was like to be invested in late 2018, the S&P 500 traded at 2,940 on 9/21/18; it went as low as 2,346.6 on 12/26/18. A nearly 600-point drop in just over three months!
Anyhow, as 2019 unfolded, things became decidedly more sanguine. The economic data being received were mostly positive numbers and while recessionary fears lingered throughout the year, they never bubbled over into anything of substance. Overall global growth slowed but sentiment about the future was still strong enough to support continued multiple expansion in the global equity markets.
All of that being said, in this author’s humble opinion, Jay Powell’s remarks on 10/3/18 caused the market turmoil that persisted for three months at the end of 2018 and his comments on 1/4/19 were the catalyst that led the US (and global) equity markets on the remarkable journey that was 2019.
On 10/03/18, Chairman Powell said, “the really extremely accommodative low interest rates that we needed when the economy was quite weak, we don’t need those anymore. They’re not appropriate anymore. Interest rates are still accommodative, but we’re gradually moving to a place where they will be neutral. We may go past neutral, but we’re a long way from neutral at this point, probably.”
Fast forward to January 2019, and Powell struck a very different chord when he said, “We’re listening carefully with—sensitivity to the message that the markets are sending and we’ll be taking those downside risks into account as we make policy going forward.” When asked if the Fed was on autopilot or would have flexibility and possibly lower rates, he responded by saying, “We wouldn’t hesitate to change it and that would include the balance sheet. We’re hearing a lot from different groups of people about the role the balance sheet normalization may be playing in the market.”
As Ian Lyngen, head of U.S. rates strategy at BMO put it “(Powell) clearly made an effort not to spook the market. He also mentioned flexibility in terms of the balance sheet, which the equity market likes.”
With Powell’s comments clearing the way for interest rates to not only not be increased but also to potentially be lowered, risk appetites started running rampant. All major global equity indices were up double digits in 2019, and even the aggregate bond index was up 8.7% on the year. A far cry from the consensus expectation heading into the year.
What’s on the Horizon?
The consensus outlook for 2020 is for more volatility, equity returns that are closer to trend levels, and higher equity prices at year-end.
Higher prices with higher volatility are what is associated with a “melt-up” in market prices. Other aspects of a melt-up would include deteriorating fundamentals and a substantial increase in investor optimism. Because all four of those components are characteristic of a melt-up, we do not think that we will see such a market in 2020. Investors still appear to have a lot of doubt and are not overly optimistic overall.
Also, FactSet is forecasting that S&P 500 earnings will grow at 9.6% in 2020 versus 2019. This is above the ten-year average annual earnings growth rate of 9.1%. All 11 sectors are projected to report year-over-year growth in earnings with five sectors expected to report double-digit growth. Surprisingly, Energy is expected to growth the fastest at 21.4% with Industrials (14.8% growth) and Materials (13.4% growth) just behind energy toward the top. Further, many leading indicators are still emitting positive signals. Therefore, fundamentals appear to be on solid ground rather than rocky footing. Combine that with the fact that the Fed still appears to be accommodative and you have the making of another positive year in financial markets.
Of course, there are risks to any positive outlook. With so much uncertainty in the world, the geopolitical tensions that exist are probably the biggest risk to our base case of slow growth, no recession, and high single-digit earnings growth.
Although uncertainties remain, we do not see a recession looming and believe there are plenty of positive developments in the global economy and financial markets that argue for remaining invested in risk assets. We see opportunities in companies that are innovating and disrupting their industries. We also believe valuations in the international arena, and the value portion of the economy are becoming more compelling.
Our outlook for 2020 is one of moderation. We do expect positive returns in 2020. Markets, however, will find it difficult to reach the lofty heights they achieved in 2019. We expect more muted returns in 2020, though, as mentioned above, we think the returns will be strong enough to justify continued ownership of risk assets in one’s portfolio.
By Charles Verruggio, VP, Senior Financial Advisor