Investor Briefing: Q4 2019 & 2020 Outlook
We begin the new year and new decade with much to be thankful for. 2019 was a terrific year for the stock market and an important year for our firm. We expanded the team and feel even better prepared to help our clients navigate the investment landscape and manage their wealth. Most of all, we are grateful to our loyal clients. While we cannot promise that every year will be as good as 2019, we will always strive to provide best-in-class advice and customer service.
2019 Performance Review
We are pleased that 2019 ended on a strong note with the S&P 500 appreciating 29%. Technology was the highest performing sector, returning 50%, followed by Financials and Communications. The lowest performer was Energy, but even this industry posted gains of 12%.
In our view, the market rose significantly for two reasons: 1) the market was oversold in the 4th quarter of 2018; and 2) the Federal Reserve cut interest rates three times in 2019. A year ago, there were fears that interest rate increases would significantly slow the US economy, if not cause an outright recession. The Fed allayed investor concerns by reversing its position on interest rates. While it is unclear whether the Fed staved off a recession, the US economy is growing at a steady rate of about 2%. In our view, this is a healthy rate of growth: not too fast to ignite inflation and not too slow to hurt job growth.
Investors in the PIFS Model Portfolio experienced very strong gains this year; the equity sleeve returned 26.3% despite a reduction to our equity exposure in the fourth quarter. Since the model was created three years ago, it has generated a 14.5% annualized return (as compared to our benchmark of 13.5%). We are pleased with its performance but remain vigilant in monitoring the funds, engaging with our portfolio managers, and reviewing the holdings on a regular basis.
Outlook for 2020
The market is off to a strong start! The S&P500 is already up around 3% year-to-date. We have a balanced view on the market outlook for 2020. We believe the economy is on solid footing and that business conditions are favorable. We expect high employment levels to support consumer spending and foresee industrial activity, which has been weakened by trade tension, taking a positive turn with a US/China trade deal. We do see these positive factors lending to a sanguine environment among investors but are concerned about high equity valuations. For this reason, we do not expect the stock market to appreciate significantly this year. Low to mid-single digit gains would be acceptable after last year’s robust performance, which is mostly in line with the expectations of other commentators. While our view does not depart significantly from industry consensus, one area where we may differ is that we anticipate the stock market to be more volatile this year which should create opportunities to make tactical adjustments to our equity exposure.
In our view, there are three major investment positives:
The economy: At the time of our letter, economists from large Wall Street banks expect the US economy to continue growing at a steady pace of about 2% in 2020. For example, Goldman Sachs estimates 2.2% real GDP growth and Morgan Stanley projects 1.8% economic growth. Importantly, recession fears seem to be abating. In fact, many market commentators are suggesting that the global economy should improve next year, which would be good for the US.
China trade deal: On the whole, investors are optimistic that the US and China will finalize a trade deal this year, possibly in phases. We see this as a reasonable expectation given it is an election year. Lowering trade barriers would likely lower costs for US importers and increase US exports. Greater trade could stimulate manufacturing activity and potentially lift economic growth above expectations.
Interest rates remain low: We expect the rate cuts from last year to positively affect business activity and investments in 2020. Because the impact of rate cuts tends to lag, the positive effects of the Fed’s actions in 2019 will continue to be felt throughout the year. Low borrowing costs make it easier for companies to invest and grow their businesses and lower mortgage rates tend to boost consumption.
While the US economy and business environment appear to be healthy, we have three concerns about the stock market.
Elevated valuations: We see signs of some investor complacency. Following the rally in the fourth quarter of 2019, the high stock market valuations give us some concern. The S&P 500 price to earnings ratio (P/E) is now 18.3x forward earnings which is 24% above the 10-year rolling average of 14.8x. When valuations are high, there is greater risk of volatility, because there is less margin for disappointing economic data.
Earnings estimates look optimistic: Wall Street analysts estimate S&P net profits to increase 6% in 2020. We view this as an aggressive estimate and expect earnings estimates to be reduced. If they are not, lower reported earnings could negatively affect the market or result in a downturn.
Election year uncertainty: Another more obvious risk surrounds the presidential elections. The Trump administration has been pro-business. A change in leadership to a candidate that is expected to increase taxes and/or regulation would likely hurt the performance of the stock market.
Our primary concern is that the market has already absorbed much of the good news anticipated over the next 6-12 months. Last year’s gains were mainly driven by valuation expansion as earnings for most S&P 500 companies were flat. This implies that the market was paying for future earnings growth. If earnings disappoint, there is significant downside risk potential.
Overall, the positive factors outweigh the negative, and the investing environment continues to look favorable to us. We do however expect the market to be more volatile this year and have taken steps to prepare for this scenario. Our portfolio has already reduced risk and if valuations remain elevated, we are likely to further raise our cash levels.
Contact Us
Phone: (215) 283-3131
Email: team@jsopartners.com