What Happened in 2019
Some feared the near-bear drawdown of late 2018 was the beginning of the end of the bull market. Indeed, many market commentaries mention being “late in the market cycle”. Age will not signal the end of this bull, however. The S&P 500 gained 31.5% even as the largest drawdown for the year was 7%, about half of the annual historic average. Asset classes rose across the board with the Barclays Aggregate Bond Index up 8.7% and international stocks up 22%. A fairly conservative diversified portfolio might have returned “only” 15% last year.
We are still a long way from euphoria, though, as a December poll of likely US voters revealed that only 40% of them thought the stock market had increased in value in 2019. 42% thought the market was flat while 18% thought it had gone down. Rather than euphoria, this market is responding to chatter around politics, IPOs (ARAMCO and WeWork), and yield curve inversions with a shrug of the shoulders.
Like every year, 2019 was supposed to be a stock picker’s mark, especially following the tumultuous end of 2018. Like most years, however, the S&P 500 beat the majority of active managers, this time outperforming 78% of the competition.
Charles Schwab’s elimination of commissions on stock trades was a boon for investors. Expect the tax-loss harvesting in your Schwab accounts to be even more efficient going forward. Reducing investment frictions is a powerful way to maximize investment dollars without having to predict the future.
2019’s Buzzwords: Trump, Tariffs, Impeachment, Brexit, WeWork, SECURE Act
Outlook for 2020
Instead of the beginning of the end, 2019 may be the end of the beginning. There is traction in trade negotiations as wrangling over USMCA comes to a close and Phase 1 of trade talks with China wrap up. Uncertainty around Brexit has diminished after the recent election. The Federal Reserve finished its “mid-cycle adjustment” and doesn’t sound ready to raise rates any time soon. Unemployment remains low and inflation is tame.
There are few calls for a correction this year, but remember that on average the market experiences a drawdown of about 14% at some point every year. Rather than fear a correction, expect one and welcome it as an opportunity to rebalance and harvest losses. One thing that we agree with the experts on for 2020 is that it will be important to remain disciplined in the face of extreme headlines.
The biggest risk we see in 2020 remains investor behavior. The actions of investors themselves are the most consistent source of success or failure. Every year there is a temptation to tweak portfolios away from what didn’t work last year to what did work. This buy high, sell low strategy gives a feeling of control, but is a wealth leech. One reason institutional investment firms don’t like to mention behavior is that it is in their best interest to get investors to DO SOMETHING, regardless of the investor’s best interest.
Having written that, I would be remiss if I did not address the biggest headline of the new year, the death of an Iranian general in Baghdad. The stock market’s response has been relatively muted. Oil has seen a small pop and is now almost exclusively quoted in the higher-priced Brent Crude flavor. US Treasury yields are down due to speculative risk-off trading. The media benefits from viewer anxiety so expect dire warnings about what could happen to lean more toward fantasy than reality. We don’t see anything that warrants altering asset allocations, especially since America’s shale revolution has diminished reliance on Middle Eastern oil. The situation is liquid and sure to change between the time the pixels dry on my screen and when you read this. Rather than anticipating market reaction to events, investors are better served by managing portfolio risk via diversification.
As is consistent with our philosophy, we continue to focus on controlling what we can control, embrace an open architecture approach, and create customized, simple, yet elegant portfolios for our clients. Portfolio rebalancing and tax loss harvesting will continue to add value without having to be “right” about any predictions. A portfolio diversified across asset classes continues to be the most prudent way to protect against risks in the market. While much of our attention is on risk, we are also looking for opportunities.
Developed and emerging international equity markets continue to look compelling from a valuation standpoint. TIPS have been an excellent source of diversification, but may add value if the inflation risk component is being mispriced by the market as a recent Vanguard commentary states. Ellen Zentner, Chief US Economist at Morgan Stanley, thinks there could be a notable pickup in inflation in 2020, particularly if wages continue to rise, foreign growth strengthens, and the US Dollar weakens.
Investors should be prepared for “Hindsight is 2020” and other dad-caliber “2020 Vision” puns.
While we don’t like the prediction game in general, we feel confident in the following election predictions. Each candidate will assert that their opponent will cause a recession or stock market crash even though the last crash due to a US Presidential election was never. Expect more voters to stay home than vote for the winning candidate. No President has beaten “Did Not Vote” since Teddy Roosevelt over 100 years ago. One last word regarding the election: If you feel that the bull market will end if your candidate doesn’t win, remember that we had a 20% drop a year ago – no election required. Investors that abandoned their investment plan at that time felt regret in the aftermath. Even as the market steadily rose, headlines made it difficult to jump back in.
Our investment committee will meet early in January to review our base allocation models and benchmarking. We’ll be discussing those updates with you during our next set of meetings. In general, we expect the following guidance for 2020:
- Maintain Bonds weighting at policy weight
- Maintain Stocks weighting at policy weight, diligently rebalancing domestic equities, but giving foreign equities more leeway as their valuations are relatively favorable