Economic Growth & Inflation
Economic growth in the United States transitioned back towards the 2% range during 2019 as the benefits of the 2017 Tax Cuts and Jobs Act gradually faded. Despite this moderate growth, overall the U.S. economy (especially the U.S. consumer) has been resilient to the global economic downturn. The longest running U.S. economic expansion on record now stands at 126 months.
Trade tensions with China went back and forth throughout the year, keeping investors on edge. Uncertainty surrounding the trade war also weighed on new business investment and manufacturing activity. However, the dispute ended the year on a positive note with the recent passage of a "Phase One" trade agreement with China. Investors cheered the news and helped the S&P 500 Index move to record high territory.
U.S. labor market conditions also remain near record setting territory with long-anticipated wage gains beginning to take hold. Despite tightness across the labor market, the Federal Reserve’s (Fed) favorite inflation gauge, core personal consumption expenditure, remains stubbornly below its 2% target. Secular disinflationary forces such as technology, globalization and an aging demographic continue to keep a lid on inflation and inflation expectations.
For the second consecutive year, global economic growth was disappointing as the narrative fully turned from synchronized global growth in early 2018 to synchronized downturn today. The International Monetary Fund now expects a 3% global growth rate for 2019, the slowest since the financial crisis. China and its primary trading partners are bearing the brunt of the U.S./China trade war with foreign central bankers running out of options for additional monetary stimulus.
Hong Kong joined the growing list of countries facing significant geopolitical tensions as violent protests increase the risk of a significant negative impact on the economic growth in the region. Hong Kong officially entered its first recession in more than a decade following a -3.2% reading for third quarter gross domestic product.
Following Boris Johnson and the Conservative Party’s recent election sweep, uncertainty remains surrounding the timing and severity of the Brexit process. UK economic growth is the slowest in nearly a decade with weak growth expected again in 2020. Disappointing economic performance in the Eurozone is not isolated to the UK, as even the relatively strong German economy is teetering near recession.
Monetary Policy
The Fed quickly reversed course to easier policy after its four-year tightening cycle concluded at the December 2018 Federal Open Market Committee (FOMC) meeting. The Fed implemented three, quarter point rate cuts at consecutive FOMC meetings beginning in July. The benign inflationary environment in the United States provided the Fed flexibility to implement "insurance" cuts to help extend the record-setting economic expansion. Fed Chair Powell has repeatedly emphasized the importance of low inflation expectations, allowing policy makers to err on the side of easy money.
However, the U-turn in monetary policy faced opposition within the Fed as Presidents Rosengren and George cast dissenting votes against each rate cut decision. They argue mid-cycle rate cuts will give the Fed less flexibility to ease in a real downturn and raise the risk that excessive leverage will create the next financial bubble. President Trump continues to lobby for even more rate cuts and ultimately negative rates to help the United States better compete on trade.
Global monetary policy is at a crossroads where the proliferation of negative interest rate policies risks doing more harm than good. The Riksbank in Sweden recently became the first central bank to end its long-standing negative rate policy. Central bankers are increasingly looking towards fiscal policy to take the lead on additional stimulus.
Interest Rates and Credit
The long-anticipated bond bear market ended almost as soon as it started with Treasury rates falling sharply throughout 2019. Long-term Treasury yields touched record low territory in late August as rates domestically followed the lead of deeper negative yields in Europe and Japan. The volume of negative-yielding debt grew to $17 trillion at its peak by late summer but ended the year below $12 trillion.
Treasury yield curve inversion dominated financial news headlines during the first half of the year as investors grew more fearful that an economic slowdown was finally at hand. The Fed’s three consecutive rate cuts beginning at the July FOMC meeting helped to normalize the yield curve and dampen recession fears in the process.
Credit markets rebounded quickly following a weak close to 2018 as the Fed’s pivot rekindled the "reach for yield" mindset among fixed income investors. Long duration government and investment-grade assets registered returns just below 20% during 2019 with high yield bond performance not far behind. BB-rated debt was the sweet spot for high yield markets as investors sought yield without taking excessive credit risk as the cycle extends.
Exhibit 1. Bond Market Performance (YTD as of 12/31/2019)
Source: Bloomberg
Equity Markets
U.S. equity markets continue to climb the wall of worry with investors tuning out the constant political noise coming from Washington, D.C. The dramatic recovery in U.S. equity markets since last year’s mini bear market frustrated bearish investors again. The old adage "don’t fight the Fed" held true again this year. In a world with persistent low or negative interest rates, investors are increasingly turning to equity markets for income.
Continuing the trend since the financial crisis, 2019 global equity market performance fell short compared to U.S. equities. Disappointing economic growth abroad coupled with rising political discord kept investment flows moving to U.S. financial assets.
September marked a possible turning point in a long-standing trend for U.S. equities - relative outperformance of growth/momentum stocks versus value stocks. The level of underperformance for momentum stocks reached levels not seen since the financial crisis and 2001 tech bubble burst.
Exhibit 2. Financial Market Performance (YTD as of 12/31/2019)
Source: Bloomberg
Now that 2019 has come to an end, what can investors expect in 2020? Be sure to check back next week for our 2020 Capital Markets Outlook!
Index Definitions:
Bloomberg Barclays U.S. Aggregate Bond Index – An index that is a broad-based flagship benchmark that measures the investment-grade, U.S. dollar-denominated, fixed-rate taxable bond market. The index includes Treasuries, government-related and corporate securities, MBS (agency fixed-rate and hybrid ARM pass-throughs), ABS and CMBS (agency and non-agency).
Bloomberg Barclays U.S. Corp High Yield – An index that measures the USD-denominated, high yield, fixed-rate corporate bond market. Securities are classified as high yield if the middle rating of Moody’s, Fitch and S&P is Ba1/BB+/BB+ or below. Bonds from issuers with an emerging markets country of risk, based on Barclays EM country definition, are excluded.
S&P 500 Index – An index of 500 stocks chosen for market size, liquidity and industry grouping, among other factors. The S&P 500 is designed to be a leading indicator of U.S. equities and is meant to reflect the risk/return characteristics of the large cap universe.
MSCI EAFE Index – An index that is designed to measure the equity market performance of developed markets outside of the U.S. & Canada.
Russell 2000 Index – An index measuring the performance of approximately 2,000 small cap companies in the Russell 3000 Index, which is comprised of 3,000 of the largest U.S. stocks.
MSCI Emerging Markets Index – A free float-adjusted market capitalization index that is designed to measure equity market performance in the global emerging markets.
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Disclosures:
The views expressed in this material are the views of PMAM through the year ending December 31, 2019, and are subject to change based on market and other conditions. This material contains certain views that may be deemed forward-looking statements. The inclusion of projections or forecasts should not be regarded as an indication that PMAM considers the forecasts to be reliable predictors of future events. Any forecasts contained in this material are based on various estimates and assumptions, and there can be no assurance that such estimates or assumptions will prove accurate. Actual results may differ significantly.
Past performance is not indicative of future results. The views expressed do not constitute investment advice and should not be construed as a recommendation to purchase or sell securities. All information has been obtained from sources believed to be reliable, but accuracy is not guaranteed. There is no representation or warranty as to the accuracy of the information and PMAM shall have no liability for decisions based upon such information.
