Goldilocks and Green Shoots Abroad?
The fourth quarter contributed to an overall standout year for global capital markets! To the surprise of many investors, the broader equity markets as measured by the S&P 500 and MSCI ACWI indexes rose an impressive 31% and 27%, respectively. Perhaps a distant memory, but the year began with elevated concerns of a looming U.S. recession on the heels of a nearly 20% drawdown for the S&P 500.
Looking ahead, our outlook for 2020 is constructive as risk seeking capital markets appear to be operating with the expectation of a renewed Goldilocks economy in the U.S. (not too hot, not too cold). Adding further support is a substantive “phase one” trade deal with China taking shape and an accommodative Federal Reserve, cutting short-term interest three times in 2019. Beyond our borders, a welcomed surprise are the tentative early signs of green shoots in global manufacturing and an improvement in the overall global economy. The combination could prove positive for stocks, particularly those outside the U.S. Although pundits continue to speculate when the prolonged U.S. expansion (now in its 127th month) will end, the day of reckoning appears to have been pushed for the foreseeable future.
While a moderate pullback during the first quarter of 2020 would not be unprecedented given the banner year, we currently view any near-term decline as part of a healthy functioning capital market. We would welcome any volatility as an opportunity to tactically exploit market dislocations and rebalance portfolios appropriately. Our focus remains on any changes that could adversely impact the economic backdrop, particularly looking to the second half of 2020. Within our asset allocation framework, we evaluate a multitude of indicators across four categories when accessing the current investment landscape.
Economic Factors and Global Market Fundamentals indicate how the market should act long-term.
Investor Sentiment and Technical Market Factors reflect how the market is acting in the short-term.
Currently, the indicators we monitor lean positive for a continued gradual economic expansion into 2020. The areas that remain the most decidedly positive or bullish are the overall economic and technical factors. For example, within the Economic Factors, U.S. GDP growth continues to muddle along at 2.1%, and unemployment remains at a 50-year historic low. U.S. consumers, who account for nearly 70% of economic actively, remain resilient and are in the strongest position since before the financial crisis. Technical Factors remain decidedly positive as the trend for global markets appears to have strong upward momentum. On the opposing side, Investor Sentiment is historically a contrarian indicator. The current sentiment readings are leaning towards elevated levels of optimism. Therefore, extreme levels of optimism (or bullishness) are a cautionary or bearish indicator - and vice versa. Global Market Fundamentals, and specifically equity valuations, remain modestly above their long-term averages in the U.S. Non-U.S. markets, and particularly emerging markets, remain the regions with the most attractive absolute and relative valuations. Overall, valuations appear less extended in the context of historically low global interest rates and accommodative central banks.
What does history tell us about the potential outcomes for 2020 given the banner year for 2019? Since 1950, in calendar years when the S&P 500 Index is up over 20%, 14 of the 17 years experienced a positive return up, on average 11.8%. Since 1950 there have only been five years with the S&P up over 30%, and in all five years following, the S&P was up 20%.
Furthermore, the equity market has been a good predicator of incumbent party success or failure in November. According to Ned Davis Research, since 1900 the Dow Industrials rallied on average into November when the incumbent Party won. Conversely, there was a meaningful average decline of approximately 7% starting in September, when the incumbent party lost.
Outflows from stock funds and into bond funds continue relatively unabated during 2019. This dynamic helps support the concept that many investors at year-end may realize they have missed out on a strong year of equity returns and feel compelled to begin rotating back into stocks during the beginning of 2020. Additionally, corporations continue to be huge buyers of their own stock, which has been a strong contributor to the performance of stocks in recent years and likely a meaningful contributor looking forward.
While our outlook for 2020 is positive, we are mindful of potential downside risks, and we have outlined below four major risks that could precipitate an economic retrenchment:
· A major setback in the U.S.-China trade war that jeopardizes global business confidence, investment spending, and global supply chains.
· Global central banks change their accommodative course and begin raising interest rates if they begin to see signs that inflationary pressures are building.
· The U.S. presidential election, where the victory of a progressive Democrat triggers a major policy shift that creates a heightened level of uncertainty.
· Additional geopolitical risks and unrest such as an escalation of Hong Kong protests and an increase in Gulf region tensions.
We concluded the year with a slightly conservative posture relative to our diversified global benchmarks with a tactical overweight to the U.S. and an underweight to traditional fixed income, while maintaining an overall short-duration fixed income allocation. Given that the outlook for global equities has improved, we anticipate increasing the allocation to non-U.S. developed and emerging market equities. Our pipeline of compelling Private Market investments remains robust. It encompasses a spectrum of opportunities and strategies for capturing the potential long-term secular drivers of global growth, while also providing diversification to niche, inefficient areas of the economy. We continue to focus on the quality of client portfolios by utilizing strategies that invest in businesses with particularly strong long-term fundamentals that we anticipate will outperform and gain market share during an inevitably challenging backdrop. As always, we will assess new information as it becomes available in order to react accordingly with changes in the global environment.
 National Bureau of Economic Research
 U.S. Bureau of Labor Statistics – November 2019
 Data provided by Morningstar Direct
 U.S. Department of Commerce – Q3 2019
All information has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy, reliability or completeness of, nor liability for, decisions based on such information and it should not be relied on as such.
The views expressed in this commentary are subject to change based on market and other conditions. These documents may contain certain statements that may be deemed forward‐looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected. Any projections, market outlooks, or estimates are based upon certain assumptions and should not be construed as indicative of actual events that will occur.
New World Advisors, LLC ("New World") is a registered investment advisor. Advisory services are only offered to clients or prospective clients where New World and its representatives are properly licensed or exempt from licensure.