2019 Market & Economic Commentary — And a look ahead

Stock markets don’t care about what is happening today. They are a forward-looking discounting machine and are more concerned about the future. This can create a disconnect between prevailing news headlines and stock market performance.

The last 12 months have been a case in point when it was easy to find lots of things to worry about. Just like HRH The Queen’s year it has been a “bumpy” road for the world economy.

Chinese growth has been weak. There has been a slowdown in the United States where companies delivered lower profits for three consecutive quarters causing the Federal Reserve Bank to cut interest rates 3 times. The Eurozone has been exceedingly weak with Germany and Italy teetering on the brink of recession.

In the UK, for most of the past year we lived in a profound state of uncertainty about both our own government and our relationship with the European Union. Brexit was the elephant in the room and cast a shadow over everything from boardroom decisions about investment to the factory floor.

Neil Woodford, a superstar fund manager, fell to earth undone by his enormous bets on illiquid assets. Travel operator Thomas Cook ran out of cash in September and had to close its doors after 178 years, leaving thousands of loyal employees out of work and more than 150,000 holidaymakers stranded overseas.

Civil unrest, political uncertainty and trade tensions all combined to create a nervous back drop for economies and financial markets.

With all these negatives it would be no surprise if stock markets were flirting with multi year lows but instead, with few exceptions, they have been testing all-time highs throughout the late autumn and early winter.

So, what is going on?

Stock markets are driven by changes in expectations. It is not the current situation that matters but what investors have priced in about the future and how that view shapes up against the underlying reality. The stock market is a manic depressive and if the consensus view of the world is negative, markets only need the outlook to become less pessimistic to deliver attractive returns.

This is exactly what happened in 2019. A year in which the S&P index in America rose by almost 30% and seemed to reach new all-time highs almost daily. Other markets lagged slightly but the MSCI All World index finished the year within striking distance of the record level it reached in early 2018. The Chinese stock market recouped all the losses of 2018 rising by a third in 2019. Even the UK market faced with unprecedented political and economic uncertainty and out of favour for much of the past 12 months, finished the year up circa 13%.

Market wisdom tells us that fear and greed are two of the main drivers of stock markets. Greed fuels the bulls and fear propels the bears, but these two emotions combined towards the end of the year. Money flowed into equity funds as a kind of fear of missing out (FOMO) mentality took hold. Investors who were sanguine about being out of the market when sentiment was grim at the end of 2018 were less relaxed about sitting on the sidelines in the latter half of 2019 when shares moved ever further into unchartered territory. As markets grind higher it becomes psychologically harder for investors to stand aside.

We must remember, however, that emotions can be a dangerous thing, particularly in investing, so a degree of caution is always required. The time of maximum risk is often when everything in the garden appears rosy but for now there are several solid reasons for greater optimism on the economic growth front as the rise in the main stock market indices testify.

Investors now believe we can avoid a recession in 2020. Stock markets rarely suffer meaningful corrections or full-blown bear markets in the absence of a serious economic downturn, so investors know that avoiding a recession is key to keeping the stock market rally on track. Employment in the major economies is high and real wages are rising. Households are also benefiting from low interest rates courtesy of central banks, so a buoyant consumer sector adds to the improving confidence. Economic Growth may be sluggish, but it is positive.

At the beginning of 2019, a comprehensive trade agreement between the US and China scored high on the wish list of all Investors. The drawn-out saga of tariffs, trade and the “art of the deal” rattled stock markets at various times throughout the year but there are now heightened hopes that some form of long-term resolution could be at hand. Trade tensions have de-escalated in recent weeks as both countries have a shared interest in defusing the two-year-old trade war. While we remain a long way from a sustainable end to hostilities, the short-term truce agreed in December now looks as though it could lead to a more permanent solution.

In the UK, the run up to the December Election was a source of tension and uncertainty for financial markets but this is now behind us with a result that the stock market embraced enthusiastically, if only because one layer of uncertainty has finally been removed. Brexit in one form or another is now assured; although the hard work in the form of trade negotiations is just about to begin.

Also positive for economic growth is the lagged impact of the Federal Reserve’s three-quarter-point mid cycle adjustment to US interest rates. The Fed may have indicated that any further reduction in the cost of borrowing will be “data dependent”, and unlikely to happen for some time, but the impact of the three rate cuts in 2019 is yet to be felt in the real economy. This will feed through in the coming months via cheaper mortgages and easier funding for companies. Meanwhile the US economy continues to be resilient to shocks with the labour market shrugging off a strike at General Motors to demonstrate that job creation is still at a healthy pace. Sentiment surveys for both manufacturing and services have also shown positive signs of bottoming out.

The overall positive outlook is being felt in the stock market and in the usually more pessimistic bond market where yields are now rising from the lows set in August in anticipation of higher growth ahead. This has the potential to trigger a positive feedback loop of more profitable banks which make their money in the gap between higher long-term yields and lower short-term rates, leading to more lending and more economic activity.

The size of the negative yielding bond market, in excess of $16 trillion dollars only a few months ago, has now fallen to less than $6 trillion as yields have risen as further indication that the normally pessimistic bond market sees better times ahead in terms of economic growth.

And so, everything feels a lot more positive at the start of 2020 than it did 12 months ago. This is good news for the economy and suggests the recent stock market rally has solid foundations. A year ago, shares were cheap, and sentiment was too gloomy. The world’s stock markets have risen substantially since then and company earnings to support that move have hardly grown but the historically low bond yields and miserly returns on cash suggest that equities are still cheap relative to fixed interest investments.

Whether you are invested in stocks and shares, bonds or property, you are implicitly assuming that monetary policy will remain easy, which we believe it most certainly will. Despite full employment, inflationary pressures remain subdued allowing central banks worldwide to continue to support markets. There is no sign that the era of easy money and low interest rates will come to an end any time soon.

The decade closed with the longest US economic expansion on record still intact and stock markets at or within touching distance of record highs. Despite the many uncertainties, it seems that investors are looking forward to a continuation of the Goldilocks era of low interest rates, low sovereign bond yields, muted inflationary pressures and the support of central banks helping to preserve the buoyancy of stock markets. Things might change and volatility is bound to ensue from time to time but for now let’s enjoy the ride. The yield on equities remains well ahead of deposit rates and the returns available in the bond markets, a recession in 2020 seems highly unlikely and company earnings should recover in the first half of this year. This is a positive backdrop for economies and stock markets as we head into the New Year and a new decade.

But while we enjoy the warm glow of one of the best years for stock markets since the financial crisis, it is worth bearing in mind that high expectations can be vulnerable to disappointment, so in the world of investment we must proceed with caution. Whatever happens in the world economy in the next few years, future returns on all asset classes; shares, bonds and property are likely to be much lower than in recent years. A robust, properly constructed financial plan and lifetime cash flow strategy, something at which Clarion excel, will be even more important to see you through the uncertainties that lie ahead.