Fourth Quarter Review

Global equity markets hit record highs capping a strong year for stocks. Easier monetary policy and re-accelerating economic growth fuelled the gains. The strengthening economy and the completion of the Fed’s easing cycle in the fourth quarter drove a bump in interest rates and a decline in bond prices.

At the end of October, to almost no one’s surprise, the Fed cut interest rates. This was the third time since August that they reduced the Fed’s fund rate. They stated that they would pause to assess incoming data before lowering rates further. The rational for the rate cut was to provide insurance from ongoing risks. The Fed’s chair, Jerome Powell stated, “there’s plenty of risk left” but some of the challenges are subsiding. The recent easing should buoy confidence and aide the economy.

The US consumer is in pretty good shape. The US economy remains resilient to most of the headwinds impacting other countries growth profiles. Data from recent jobs reports is strong despite Boeing’s issues and its impact on its supply chain. Rising average hourly earnings continues to induce more workers to enter the workforce leading to an expanding labour pool.

Corporate earnings reports were better than feared, which tends to be supportive of a continued upward movement in stock prices. Companies have been maintaining future guidance, which is positive considering the trade rhetoric and tariff fears. Industrial companies have communicated that the mid-year inventory destocking is nearing an end. This is most evident by the bottoming of the Purchasing Managers Indexes (PMI’s).

Green shoots from Europe signify a pick-up from near recession levels. Autos, housing and manufacturing PMI’s all have been positive recently. The Chinese economy appears to be rebounding based on accelerating industrial production data. After lengthy on-again / off-again negotiations, China and the US have reached a tentative mini trade deal. While positive, it is not the all-encompassing deal that the market hoped for.

The presidential impeachment trial and the upcoming 2020 election are both risks that should not be ignored. As the Republicans control the senate, it is unlikely that President Trump will be convicted for impeachment. Based on publicly available evidence, it is improbable that enough republicans senators will be persuaded to change their stance and vote against the president.

The election risk is related to the uncertainty of who will be the next president. How will investors respond if it is likely that Trump remains in office for another four years? How would confidence be impacted if Elizabeth Warren was the president elect? Her expansion of government and the big tax increases required to pay for these programs could put a chill on the economy. On the other hand, the markets would probably respond positively if Michael Bloomberg was the president elect as he is viewed more of a centrist.

The Stock market remains near record highs, and valuations remain full. Corporate earnings are expected to grow 8% this year. Low interest rates and no impending recession continues to support an extension of the bull market. The only caveat is that gains in 2020 will not be as robust as in 2019 and we should expect elevated volatility. While volatility is typically not perceived as a positive, it should not impact long term investors.

Bonds had a poor fourth quarter but a remarkably good year considering the low yields at the start of the year. It surprised us that interest rates declined as much as they did in the second half of the year. The slower economy led central banks to reverse course and begin easing. Central banks have again reversed course signalling that the easing cycle is complete implying interest rates are unlikely to decline further.

We continue to prefer equities over bonds. Although bonds had a great year (+6.9%), they still underperformed equities. Going forward, stocks should benefit from an improvement in US business activity, trade deals between Canada, Mexico and the US and a US – China trade deal. A deal to keep the US government operating for another year, avoiding a repeat of this year’s shutdown is also positive. The results of the UK election also eased some uncertainty about the how and when the UK will leave the European Union. We expect moderate economic growth in 2020, with the downside risk being less severe than three months ago.

As always, we welcome your thoughts and comments.