Nicholas A. Juhle, CFA®

Senior Vice President, Director of Research

2019 Review and 2020 Outlook

What a difference a year makes. In our 2018 year-end seminar we recapped a period where almost every major asset class posted disappointing returns as investors grew increasingly concerned by the prospect of a global economic slowdown. To the pleasant surprise of most observers, 2019 unfolded as a year characterized by stronger-than-expected returns across most asset classes and a firming economic backdrop heading into 2020.

Throughout 2018, but particularly in the 4th quarter, investors became increasingly anxious about the prospect of a recession, reacting sharply to any data point or headline that could signal a slowdown. While many of the economic concerns contributing to the 2018 experience carried into the new year, most asset classes more than recovered in 2019.

Global Equities: In 2018, global equities declined 9%. Domestic large caps fared “best” (down 4%) while developed international and emerging market stocks posted double-digit declines. In 2019, global equities gained nearly 27% led by domestics (+31%), followed by developed international (+22%), and emerging markets (+18%).

Fixed Income: In 2018, key rates spent much of the year above their starting points, resulting in flat to negative returns across most bond indices. In 2019, rates have moved lower. From a starting point of 2.68% on the US 10-year treasury, rates bottomed at 1.46% in early September and closed the year at 1.92%. As a result, core bonds posted returns in the mid- to upper-single digits.Key sources of uncertainty in 2018 included Federal Reserve Policy and US/China trade negotiations. Unsurprisingly, these themes carried significant influence in 2019 as well. These issues, and some new ones, including a presidential impeachment and the 2020 election, will also shape the year ahead.

Federal Reserve: The Fed raised interest rates four times in 2018 and projected two additional increases in 2019 when the year started. By the end of the first quarter, policymakers reduced expectations from two rate increases to zero, while markets priced in two to three cuts. The markets turned out to be right as the Fed moved to accommodate cutting rates three times (25 bps each in July, September and October) in a “mid-cycle policy adjustment.” In December, the Fed held rates steady – maintaining the range of 1.50%-1.75% – and signaled intentions to maintain the range through 2020 citing economic strength and a healthy labor market.

Trade Policy: Evolving trade policy escalated into an all-out trade war between the US and China in 2018. In May 2019, a trade deal between the world’s two largest economies seemed imminent when officials unexpectedly moved to increase tariffs, derailing talks. Negotiations progressed in October, resulting in plans for a three-phased agreement. Both sides came to terms on phase one in early December, just in time to avoid additional tariffs. Progress (or deterioration) on the US/China trade front will continue to influence the market narrative in 2020. Visibility into future phases remains limited, but we continue to believe each country’s economic interests favor a fully negotiated deal.

Impeachment: In 2019, the markets seemed to shrug off impeachment proceedings of President Trump. In September, House speaker Nancy Pelosi announced a formal impeachment inquiry, which led to approval of two articles of impeachment in December for which the Senate will try the President in January. Given the partisan nature of the issue, a Republican majority in the Senate makes it a foregone conclusion that President Trump will be acquitted and we are not expecting significant investment implications from the process.

Presidential Election: Looking ahead to the 2020 election, there is no shortage of bold market predictions based on potential election outcomes – and this is nothing new. Several well-known hedge fund managers have described the market swings that could occur if Warren, or Sanders, or Trump, or [pick your candidate] wins. We view all such predictions with a great deal of skepticism as there is very limited data to suggest that one individual (even the president of the United States) will single-handedly move the markets dramatically higher or lower. See our piece from the December Perspectives newsletter: “Vote With Your Ballot, Not Your Portfolio” for a deeper dive on investing in election years.

Having crossed the ten-year mark in June, the current economic expansion is officially the longest on record. Exiting 2018, we were perplexed by markets that seemed to anticipate immediate recession despite data that portrayed a healthy economic backdrop. We monitored key recession indicators throughout 2019 and believe we are entering 2020 on solid footing.

Yield Curve: An inverted yield curve (short-term yields exceed longer-term yields) has historically been a useful indicator of future economic growth. The yield curve inverted 4-24 months prior to each of the last seven recessions – there were also two false positives (inversions without recessions). In March of 2019 the yield curve inverted, triggering this indicator for the first time since the great recession. The curve is not currently inverted, thanks in part to accommodative policy adjustments from the Fed.

Unemployment: The labor market is another indicator of recession risk as rising unemployment can foreshadow economic contraction. The unemployment rate has historically bottomed an average of nine months before the onset of a recession. Unemployment currently stands at a 50-year low of 3.5%. It is difficult to identify a trough in real time, but it appears that the labor market remains strong and in position to support continued consumer spending heading into 2020.

Real Retail Sales: Consumer spending makes up the majority of US GDP, so real year-over-year declines in retail spending can indicate that a recession is near. In December 2018, real retail sales declined 0.3% triggering this indicator, but growth rebounded in 2019 averaging +1.6%. Further, US shoppers reportedly spent 3.4% more this holiday season in spite of the fact that the traditional holiday shopping season was six days shorter than in 2018.

All in, real US GDP will likely have grown 2.3% in 2019, compared to 2.9% in 2018. This outcome is consistent with the expectations of 2.0%-2.5% we detailed this time last year – slower than 2018, but not unhealthy and far from a recession. Looking ahead to 2020, we expect growth to decelerate modestly to a likely range of 1.5%-2.0%. As we approach the twelfth year of the current economic expansion, GDP growth of 1.5%-2.0% represents return to a normalized and sustainable level of economic growth.

As for the market experience going forward, we share our updated capital market assumptions below. These forecasts represent our expectations for average annualized returns for each asset class over the next ten years. Over the next decade, there will be years where returns exceed our expectations and years where returns trail our expectations. We believe short-term market-timing strategies are unlikely to improve long-term outcomes. Said another way, we encourage our clients to stay disciplined in years like 2018 so as not to miss out on years like 2019.

Asset Class 10 Year Expected Return

(Dec 2019)

10 Year Expected Risk

(Standard Deviation)

US Large Cap 4.5% 14.0%
US Mid Cap 6.3% 16.0%
US Small Cap 7.0% 19.0%
Developed International Equities 6.0% 17.0%
Emerging International Equities 8.0% 22.0%
Core Fixed Income 2.5% 4.5%
Non-Core Fixed Income 3.8% 10.0%
Diversified Alternatives 4.3% 7.5%
Cash 1.8% 0.5%

Source: Greenleaf Trust, as of 12/31/2019

We continue to recommend most of our clients hold a full weight to global equities in accordance with their individualized risk profile and we remain marginally more constructive on international equities. Concurrently, we are less constructive on the outlook in fixed income markets and believe a modest underweight in favor of an allocation to diversifying strategies (alternative assets) remains prudent.

Despite an ever-changing landscape, our disciplined approach and long-term orientation serve us well in our quest to create comprehensive investment solutions that help our clients reach their financial goals. Investment decisions are made in alignment with our documented investment philosophy and always with the intention of serving our clients’ best interests. Happy New Year and thank you from everyone on the investment research team for allowing us to serve on your behalf.