The Cornerstone Investment Commentary: 4th Quarter 2019
Happy New Year (and Decade)! The financial press is hailing 2019 as one of the best ever for global stocks. But to focus on this – and the question of whether it can continue – is to be fooled by the calendar and to miss some key evidence pointing to an attractive investment climate as 2020 begins.
Results in 2019 were indeed eye-popping: U.S. equities gained between 22% (small-cap value) and 36% (large-cap growth). Foreign markets were up 20 – 22%; both developed and emerging country indexes fared about the same. Bonds gained 4 – 10%, with the highest returns in longer-term bonds.
Last year’s gains were so great because losses during the last three months of 2018 were so large:
|S&P 500 Index||S&P 500 Earnings||Valuation (P/E)Ratio|
17.2 (2,898 / 169)
|31DEC 2018||2,478 (-15%)||$164||
15.1 (2,478 / 164)
|3,219 (+30%)||$177 (estimate)||
18.2 (3,219 / 177)
Overall in the last 15 months, large U.S. stocks – the S&P 500 – rose 11%, from 2,898 to 3,219. By Fall 2018, the Federal Reserve (Fed) had raised short-term interest rates to 2.25%; further increases were expected. Rates at that level (and rising) make it hard on stocks when their Price/Earnings (P/E) level is a modest 17.2. As if on cue, they promptly fell. In 2019, the Fed reversed course and cut rates by 30%, from 2.5% to 1.75%. These lower (and falling) rates boosted corporate profits and were a balm for stock prices; not even multiple ‘trade war’ uncertainties could stop them. The P/E ratio starting 2020 is 18.2.
Lower interest rates typically allow higher stock market valuations. This matters more than fears about ‘record highs’ or ‘over-valued stocks’. If interest rates hadn’t fallen, we would now be concerned. Of course, unexpected events such as new tariffs, a spike in wage inflation or global event shock could change the picture overnight. This is why we believe, even after recent gains, there’s no need to become more conservative beyond normal rebalancing. However, a more aggressive stance does not seem prudent.
In 2019, it again paid off to not increase foreign stocks and lower U.S.; the U.S. is still the world’s best-positioned economy. The same is true for our lower small-cap allocation relative to large. Additionally, 90% of your portfolio’s active managers bested their benchmarks over the past three years.
As for fixed income, intermediate-term holdings out-performed short-term bonds as our partial shift in this direction a year ago worked well. However, since it appears the Federal Reserve has finished cutting rates for now, continuing to hold ~80% of your bonds in shorter-term holdings seems appropriate.
Of course, we will be watching how markets react to unfolding economic and political events this year.
With all wishes for a healthy and happy 2020, thank you for the continuing opportunity to work with you.