The equity market rally picked up steam in the final quarter of the year as investors cheered a deescalation of trade tensions with China, signs of bottoming economic data, corporate earnings results that were better than feared, and the Federal Reserve’s third interest rate cut in 2019. The S&P 500 Index posted an impressive fourth quarter return of 8.5%. Equity markets outside of the U.S. also performed extremely well with international stocks (MSCI EAFE Index) advancing 7.8% and global stocks (MSCI All-Country World Index) registering a 9.0% quarterly gain.
Fixed income performance was more subdued than the previous three quarters of the year. Interest rates found at least a near-term bottom in late August/early September and ticked higher in the fourth quarter. With the backdrop of a modest increase in interest rates, the Barclays U.S. Aggregate Bond Index eked out a gain of 0.2% for the quarter.
A comparison of 2018 and 2019 asset class returns is illustrated below. Strong returns were not isolated to a few sectors or asset classes. 2019 was the year of the “everything rally” as all asset classes advanced with most posting double-digit returns. Obviously, a much different outcome than 2018.
Heading into the fourth quarter, many investors questioned if the weakness in global manufacturing would spill over to other segments of the economy and negatively impact the U.S. consumer. However, all indicators still point to a healthy U.S. consumer supported by the lowest unemployment rate in a half century, rising wages, low interest rates and benign inflation. Consumer strength was a consistent theme throughout the year and apparent in retail sales data and confidence readings.
While global manufacturing activity remains weak, signs of a bottoming out process emerged in the fourth quarter. This may be attributable to easing trade tensions and diminished fears of a severe economic downturn. It remains to be seen if we will see a meaningful upturn in manufacturing activity, but stabilization is a good first step.
We start the new year with expectations for a rebound in economic growth and corporate profits. Essential components of this view include – diminished trade tensions, accommodative global central banks, a strong U.S consumer, and an end to the global inventory overhang, which should translate into a pickup in manufacturing activity. Also, flattish corporate earnings growth in 2019 sets the bar low for 2020 comparisons. That is the good news.
The bad news, in our view, is that there is already plenty of good news and optimistic assumptions priced into equity markets. The almost 30% advance in the S&P 500 Index in 2019 was driven almost entirely by multiple expansion — essentially investors paying more for the same level of corporate earnings. This has translated into equity market valuations expanding from below long-term historical averages at the end of 2018 to a measurable premium at the close of 2019. In our view, corporate earnings growth will need to drive equity market returns from current levels.