Perspectives | 2019: A Winning Year in Review
U.S. Equities: What Downturn?
Domestic stocks continued their bipolar ways in 2019. After a relatively calm 2017, investors were treated to a volatile and train-wreck-esque end to 2018, only to see a complete reversal of fortune in 2019. In fact, it would have taken a lot of work to not earn 10% or better on your domestic equity investments last year. The benchmark S&P 500 Index kicked off 2019 with a strong 8% gain in January and went on to post gains in 10 of the 12 months finishing the year with a 31% return. May’s ‘hiccup’ of negative 6% was erased the following month in June with a 7% rebound as investors shrugged off trade rhetoric, the potential of slowing Chinese economy, some manufacturing weakness and volatile oil prices. Each of the 11 primary sectors posted a gain during the year ranging from 50% for information technology to a still healthy 12% return in the energy sector. Mid-caps stocks were in close pursuit with the Russell Mid Cap Index returning an equally strong 30.5%. Small-cap stocks weren’t exactly an embarrassment either with the S&P SmallCap 600 Index gaining 23%.
International Stocks Gain Amid Uncertainty
Non-U.S. equities lagged on a relative basis but still produced strong returns. The MSCI EAFE Index returned 22% as all but one developed nation (Yes, we’re looking at you Luxembourg) posted a positive gain ranging from 8% to 35%. The Conservatives won the necessary majority in the December election in the United Kingdom, meaning that the UK-EU Brexit will likely happen. But the finish is far from certain, as many trade deals and details have barely been discussed. Emerging market economies also rode the tide of upward equity prices last year, with the MSCI Emerging Markets Index gaining 18%. Chile was the outlier with a 16% loss, while gains ranged from slightly above even to more than 50% for Russia and Greece. Overall, U.S. stocks have been the place to be post-2008 Financial Crisis, as the S&P 500 Index’s 14.7% annualized gain is well ahead of the 7.7% and 9% gains of international developed and emerging markets, respectively.
Beware of Bond Math
Stocks and bonds are complimentary investments in a portfolio for diversification purposes. So…if stocks were up big in 2019 that means bonds were…up big too! Wait, what? 2019 was also a banner year for bonds thanks in part to investor demand for yield and multiple interest rate cuts by the Fed. After setting the expectation for future rate hikes to zero at the end 2018, the Fed did the bond market one better and lowered the target interest rate three times in 2019. Core bonds responded by rallying all year, with the Bloomberg Barclays Aggregate Bond Index posting a gain in 11 of the 12 months and ending the year up 8.7%. The sister Corporate High Yield Index followed suit with a strong 14% gain.
But bonds don’t have the theoretical unlimited upside gain of stocks. A bond is essentially a loan. You give someone capital, they pay you interest and then return your capital at a specified time. As a result, the annualized return of a bond investment is essentially the starting yield when you buy a bond (accounting for the fact that bonds aren’t always bought at a par value of 100). Since the total return is fixed (total interest payments + gain/loss of a bond’s value moving to par value) any large fluctuation in returns from year to year will mean-revert in future years. Paltry bond returns in 2015 were ‘made up’ in 2016 and then somewhat normalized in 2017. The abnormally large total returns seen in asset classes such as core and high-yield bonds last year were nothing more than a true-up of the below-yield returns seen in 2018. Rewind the clock back to the end of 2009 as the bond market had begun to normalize following the financial crisis. At the end of that year, the iShares Core U.S. Aggregate Bond ETF had a 12 month yield of 3.9%. Fast forward and the annualized return of that ETF from 2010-2019 was…3.7%. That’s a pretty good approximation. Today, core and high-yield bonds have a 12-month yield at the end of 2019 of 2.7% and 5%, respectively.
Keeping Your Eyes on the Road in 20/20
There will be multiple near-term distractions to divert a long-term investment focus this year. Military action in Iran and the ongoing impeachment proceedings will undoubtedly contribute their fair share of headlines. The Brexit process as well as an upcoming Presidential election will create both uncertainty and clarity later this year as the market digests the impact of potential regime changes. It is safe to say that any news is going to be met with wild overreaction in the short-term, as the impact of any material change will not fully manifest itself for multiple years. As such, stay focused on your investment plan and objectives and mute the day to day opinion pontificators.