This Market Outlook will be my fourth since joining First Command as Chief Investment Officer in January of 2017. The annual Market Outlook is our tradition of looking back at what happened during prior years and letting you know what our expectations are for the upcoming year. I want to begin by comparing the last three years of economic and market performance.
The economic fundamentals in place over the last three years were solid and consistent – slow growth, low inflation, low unemployment, and low interest rates. Two stark distinctions were the market volatility that began in 2018 and continued in 2019 and earnings growth that materially slowed in 2019. The volatility was primarily the result of tariff skirmishes between the U.S. and its major trading partners and rookie mistakes by Federal Reserve Chairman Jerome Powell. The slowdown in earnings growth on S&P 500 companies was not unexpected after the white-hot positive numbers of 2017 and 2018. Some might think that the very low earnings growth in 2019 was a market letdown. It was not. It was viewed as a positive surprise, as equity analysts expected a contraction in U.S. corporate earnings. Against this largely positive economic backdrop, the S&P 500 posted strong returns in 2017 and 2019 and a slightly negative return in 2018. The lesson here is that a good economic environment does not always guarantee positive equity returns.
Comments on Our 2019 Estimates
Our 2019 range estimates were accurate for global and U.S. economic growth, inflation, and unemployment as you can see from looking at the table below. We anticipated the slowdown in economic growth and projected that inflation would soften due to the general economic slowdown, less demand for commodities, and increased U.S. productivity. We also observed that continued low unemployment that generally causes wage inflation was not making its way into the overall inflation number. We were directionally correct about a slowing down of growth in U.S. corporate earnings, although the 1.1% S&P 500 earnings growth rate logged in 2019 was slightly below our range estimate.
Our biggest surprise in 2019, however, was the lowering of U.S. interest rates. We believed that the U.S. Central Bank (the “Fed”) would either keep short-term rates the same or increase them by 0.25%. Instead, the Fed, responding to a slowing economic growth scenario here and abroad and the tariff skirmishes with our major trading partners (which increased market volatility throughout the year), reduced the Fed Funds rate three times (0.25% each time). We believed that the U.S. economy did not require any rate cuts due to its underlying strength. Chairman Jerome Powell begged to differ. In our view, the Fed’s rate cuts were an insurance policy the U.S. Central Bank took out to increase the probability of continuing the current U.S. economic expansion, which is now the longest on record.
Regarding long-term interest rates, they came down quite substantially, primarily due to increased global demand for the 10-year U.S. Treasury note caused by: (1) very low or negative sovereign bond rates overseas and (2) buyers looking for a safe haven during periods of market stress. We saw longer maturity U.S. rates become somewhat tethered to overseas rates. As foreign sovereign bond rates came down, increased demand for higher-yielding U.S. government bonds brought yields down as well. As buying of U.S. Treasury debt increased, prices went up and yields came down. Although incorrect in our estimates of short and long-term U.S. interest rates, there was a silver lining. We did not expect bond values to appreciate significantly in 2019, but due to falling rates, they performed surprisingly well.
Looking ahead to 2020
Every year in early December, our team of investment professionals at First Command come together to review economic data from multiple sources in order to prepare our 2020 estimates. Normally, there is vigorous debate on our predictions. This year, however, there seemed to be a quiet consensus regarding our 2020 Market Outlook. If I had to summarize our outlook, I believe the operative word would be “ditto” – because we think that 2020, from an economic standpoint, will look similar to 2019. We do, however, anticipate a slight uptick in the growth rate of U.S. corporate earnings.
GDP = Gross Domestic Product and is an estimate of economic output.
As of the end of December 2019, we are 126 months, or 10½ years, into the economic expansion that began in July 2009. That makes it the longest expansion since we began keeping track in 1856!
Do you feel it yet? I ask this question of clients when I travel around to many of our offices during the year. Most respond that they “hear” it is the longest on record, but that they do not “feel” it. There is something behind this. In previous long business expansions, cumulative economic growth has been robust, and U.S. economic output has increased by almost half. Our current record-breaking economic expansion has expanded U.S. economic output by less than 25%. This slow and steady growth is the reason why we do not truly “feel” this economic expansion.
As I noted last year, business expansions do not die of old age, they die for cause. The ordinary causes are high interest rates, high inflation, over-leveraged U.S. companies and individuals, restrictive lending, and/or an overheating economy. We still are not seeing any of these signs of recession. Instead, we are seeing signs of positive contributors to an economic expansion that you would normally see in the early stages of a business expansion (not the late stages which we are arguably in right now). Acclaimed economist Jim Paulson recently made the following observation:
“At the same time, oddly enough (or perhaps, par for the course in what has been the oddest recovery ever in post-war history), there are significant signs of unused capacity which make this recovery and its corollary bull market appear much younger than its birthday.
Calendar-old recoveries do not generally enjoy a silent productivity pop, a late-cycle rise in the labor-force participation rate, a household formation surge, extremely strong and liquid consumer balance sheets with unused accumulated savings.....”
Although this economic expansion has been weaker than similar long expansions, that may have its advantages. As market prognosticator Ed Yardeni likes to say, where there is no “boom,” it is hard to have a “bust”. Speaking in round numbers, we are averaging about 2.0% annual economic growth during this business expansion. We expect more of the same for 2020.
As I mentioned last year, the unemployment rate is tricky to predict. Why is this? If an economy improves, it incentivizes those out of work to begin actively looking for work. If that happens, the unemployment rate will increase for a short time as workers are assimilated back into the work force. This is counterintuitive, as we generally equate a strong economy with lower unemployment. Having said that, we believe that the unemployment rate will stay low. The U.S. job market continues to show strength. Currently, there are about 7 million job openings in the U.S. and about 6 million workers actively looking for work. This is important because U.S economic growth is primarily driven by consumer spending. The more workers who are earning wages, the more consumer spending increases. And the more consumer spending increases, the more U.S. economic growth increases. A robust job market creates a virtuous circle that is likely to result in continued U.S. economic growth.
We have had very low inflation over the last decade. In 2019, we saw an inflation rate of 1.8%. A long business expansion typically results in a rising inflation rate, driven by scarce (and higher priced) commodities and higher wages from a tight labor market. This has not happened. A slowing Chinese economy and technological advancements in oil and natural gas extraction have softened commodity prices across the globe. Also, higher U.S. wages stemming from the tight U.S. labor markets have not found their way into the overall inflation rate. Many economists point to higher “hidden” productivity due to technology advancements as the reason for this mysterious result. Add to this equation a slow economic growth scenario for the U.S. and overseas economies and that leads us to anticipate continued low inflation in 2020.
The Fed has a great degree of control in setting U.S. short-term interest rates, but that’s not the case with long-term interest rates. Long-term interest rates are primarily controlled by buying and selling in the capital markets.
We anticipate that the Fed will either decrease the short-term interest rate once in 2020 (most likely by 0.25%) or leave the rate unchanged. This is supported by our view that the Fed did not need to reduce rates in 2019, but rather did so as a safeguard against the global economic slowdown and to reassure markets during the tariff fights. If the strength of the U.S. economy did not need the rate cut then, it surely does not need a rate cut now given our economic growth projections. In his October 30th press conference, Fed Chair Jerome Powell said, “[s]o I think we would need to see a really significant move up in inflation that’s persistent before we would consider raising rates to address inflation concerns.”
Ten-year U.S. Treasury notes ended 2019 at 1.92%. As we discussed in our review of our 2019 Market Outlook, long-term interest rates are low primarily due to increased global demand for the 10-year U.S. Treasury note caused by very low sovereign bond rates overseas and buyers looking for a safe haven. We do not see either of these reasons changing in any substantive way in 2020. Overseas rates should remain low, buyers will continue to purchase long-term U.S. debt to safeguard assets (as 2020 is looking to be another volatile year), and inflation should remain subdued. As a result, we anticipate that the rate on the ten-year U.S. Treasury note will remain range-bound between 1.50 – 2.25%.
From an economic standpoint, the last three years have been quite conducive to positive stock returns. But, returns on the S&P 500 were positive in 2017 and 2019, but negative in 2018 (-4.38%). A positive economic environment can help stock returns, but it is not a given. Stock returns during 2019 were:
U.S. Large Company stocks: 31.49%
U.S. Mid Company stocks: 30.54%
U.S. Small Company stocks: 25.52%
Foreign Developed Markets: 22.49%
Emerging Markets: 18.42%
These positive returns came with a lot of twists and turns, ups and downs, and large degrees of volatility. We expect the economic background in 2020 to be similar to the last three years. We believe that U.S. corporate earnings growth will increase slightly and be supportive of rising stock prices. From a valuation standpoint, the S&P 500 is trading at approximately 17.9 times (17.9x) its projected 1-year forward earnings estimate. That compares to a five-year low of 13.9x during December 2018 and a 16-year high of 18.6x during January 2018. It is well below the tech-bubble record high of 25.7x in July 1999.
Our viewpoint is that stocks are slightly over-valued, but not unduly so. In this type of environment, stocks should have the wind at their backs during 2020. Of course, unexpected events can present themselves at any time, so there is no guarantee of positive returns. The one thing that seems certain is that market volatility will remain high. The next year is chock full of U.S. and global items that will increase market uncertainty – the impeachment proceedings against the President, continuing political skirmishes in D.C., Brexit, global trade conflicts, an aging U.S. economic expansion, the upcoming presidential election, and the list goes on.
What does this mean to you?
First Command continuously assesses economic and market conditions. Currently, they look mildly positive for 2020, much as they did last year. Stock volatility will continue to be high due to the reasons discussed above. We passionately believe, however, that a well-designed, globally diversified portfolio that is aligned with your financial plan, investment time horizon, and risk tolerance is the best approach to help you pursue your financial goals in uncertain markets. Please consult your First Command Financial Advisor about any comments, questions, or concerns you may have.
Thanks for taking a look!
John S. Weitzer, CFA
Chief Investment Officer
The information in this report was prepared by John Weitzer, Chief Investment Officer of First Command. Opinions represent First Command’s opinion as of the date of this report and are for general informational purposes only and are not intended to predict or guarantee the future performance of any individual security, market sector or the markets generally. First Command does not undertake to advise you of any change in its opinions or the information contained in this report. This report is not intended to be a client-specific suitability analysis or recommendation, an offer to participate in any investment, or a recommendation to buy, hold or sell securities. Do not use this report as the sole basis for investment decisions. Do not select an asset class or investment product based on performance alone. Consider all relevant information, including your existing portfolio, investment objectives, risk tolerance, liquidity needs and investment time horizon. Should you require investment advice, please consult with your financial advisor. Risk is inherent in the market. Past performance does not guarantee future results. Your investment may be worth more or less than its original cost. Your investment returns will be affected by investment expenses, fees, taxes and other costs.
©2020 First Command Financial Services, Inc. parent of First Command Financial Planning, Inc. (Member SIPC, FINRA), First Command Advisory Services, Inc., First Command Insurance Services, Inc. and First Command Bank. Securities and brokerage services are offered by First Command Financial Planning, Inc., a broker-dealer. Financial planning and investment advisory services are offered by First Command Advisory Services, Inc., an investment adviser. Insurance products and services are offered by First Command Insurance Services, Inc. Banking products and services are offered by First Command Bank. Securities products are not FDIC insured, have no bank guarantee and may lose value. A financial plan, by itself, cannot assure that retirement or other financial goals will be met. In Europe, investment and insurance products and services are offered through First Command Europe Limited. First Command Europe Limited is a wholly owned subsidiary of First Command Financial Services, Inc. and is authorized and regulated by the Financial Conduct Authority. Certain products and services offered in the United States may not be available through First Command Europe Limited.
All estimates provided are for informational purposes only and should not be relied on to make investment or other decisions. Should you require investment advice, please consult with your financial advisor. Risk is inherent in the market. Past performance does not guarantee future results. Your investment may be worth more or less than its original cost. Your investment returns will be affected by investment expenses, fees, taxes and other costs.
The S&P 500 Index is widely regarded as the best single gauge of the U.S. equities market. This world-renowned index includes a representative sample of 500 leading companies in leading industries of the U.S. economy. Although the S&P 500 Index focuses on the large-cap segment of the market, with approximately 75% coverage of U.S. equities, it is also an ideal proxy for the total market. An investor cannot invest directly in an index.
- International Monetary Fund (IMF), Morningstar (2020), and Bloomberg (2020).
- As measured by the 10 year U.S. Treasury note.
- Canada, Mexico, the European Union, Japan, and China.
- Fed Reserve Chairman Jerome Powell gave an ill-advised hawkish interview that caused a market panic in October 2018. One could also argue that the President, who is not a polished politician, also increased market volatility due to the novel use of Presidential “tweeting” on Twitter.
- The current U.S. economic expansion began in July 2009 and as of the end of 2019 is 126 months old (10.5 years)!
- Bloomberg (2020) and First Command Investment Management Team. Estimates are as of 1/3/2020. Forecasts are not guaranteed and are subject to change. Past performance is no guarantee of future results.
- The longest economic expansion prior to the current one was from March 1991 – March 2001, which lasted 10 years or 120 months. National Bureau of Economic Research (www.nber.org) (2020).
- “Unused Capacity” by James Paulsen, Chief Investment Strategist at The Leuthold Group (December 2, 2019) (emphasis added).
- U.S. consumers account for around 70% of U.S. economic output so a growth in the labor force is good for a healthy and growing economy.
- Yardeni Research (2019).
- Morning Briefing, Yardeni Research, Inc. (December 18, 2019).
- Morningstar (2020).
- Morning Briefing, Yardeni Research, Inc. (December 17, 2019).