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2019 Review and Outlook

Executive Summary:

  • The Nasdaq 100 had its best year since 2009 cementing an historic ten years of outperformance.
  • The 2019 rebound included strong performances across nearly all sectors and market caps.
  • Global exchanges rebounded from an abysmal 2018 aided by a new wave of central bank easing.
  • Three rate cuts, new repo programs, and a new $60B Treasury bill purchase program (QE4 lite) helped reduce stresses in short term funding markets and unwind the inverted yield curve.
  • Global trade wars and social unrest were widespread but equities were strong nonetheless.

It is said all bull markets climb their own wall of worry and 2019 proved that to be the case more so than any other year in modern times. Headwinds were strong across the global landscape including a weak global economy and manufacturing recession, flat to negative corporate earnings, yield curve inversion and recession risk, elevated geopolitical risks and social unrest, volatile and unresolved trade wars, and monetary policy uncertainty just to name a few. On December 18th the House of Representatives impeached the President of the United States but stocks continued to hit new daily highs in December and U.S. equities plowed ahead for their best year since 2013 driven by a resilient U.S. consumer and arguably more importantly a dovish pivot by the Federal Reserve.  For the Nasdaq 100 it was its best year since 2009. 

Despite a record government shutdown (35 days) ending on January 25th, January was the stock market’s best month in 2019 as equities were then rebounding from one of the worst Decembers on record and a 20% decline in the S&P500 in Q4’18. The U.S. – China trade war was the biggest story of the year and regular changes to its expected outcome added volatility to the markets. The rhetoric and fear hit extremes in early August when Trump responded to a hawkish rate cut by threatening to impose 10% tariffs on an additional $300B in Chinese goods.  Equities reacted with a relatively modest pullback, but rates crashed and the long end of the curve saw its second biggest monthly decline in ten years. In the fall expectations rose for a watered down “Phase One” deal which is now expected to be signed on January 15th. Mixed in throughout the year were tariff threats against Mexico, Brazil, and Argentina. President Trump largely stifled the tariff rhetoric when it came to Europe, but that tweetstorm could come in 2020. 

Social and political unrest were common throughout the year. In September, Saudi Arabia’s oil and refining facilities were attacked by a string of drones and missiles leading to the largest ever one day percentage gain in crude oil.  Anti-government demonstrations erupted across the globe with citizens protesting various forms of taxation, human rights, and corruption, however the protests in Hong Kong drew the greatest interest leading the U.S. to pass human-rights legislation. Risks of a no-deal Brexit declined in December after UK Prime Minister Boris Johnson won the December 12th election. Britain’s departure from the EU has been delayed three times, but it could now be on course to leave by the end of January. 

If trade wars were the biggest story for 2019, the Federal Reserve was a close second. After repeated hawkish commentary throughout Q4’18 contributed to the largest S&P 500 correction since the 2008 financial crisis, Chairman Powell did an about face (i.e. “dovish pivot”) in early January by essentially saying the balance sheet reduction program was no longer on auto pilot. In the ensuing months, the increasing trade war rhetoric, falling inflation expectations, weakening economic data, and curve inversion drove the Fed into a “mid-cycle adjustment” of three 25bps rate cuts in as many meetings commencing on July 31st. Literally days before the second meeting in September, the Fed lost control of the short term funding markets as overnight repos ballooned to ten percentage points and the Fed Funds Rate rocketed 75 bps above the top end of the 2% – 2.25% target range. Temporary repo facilities and a $60B monthly Treasury bill purchase plan were quickly implemented, and the government’s balance sheet rose 11% from its low of $3.76T on 8/28 to $4.17T in late December. So much for auto-pilot. Powell made it clear the bill purchases were not QE, but with roughly $6T – $7T of paper that needs to be rolled every six months, some speculate this is the start of QE4 which in time may require the purchases of longer dated maturities. If the message was not yet received, the Fed’s dovish pivot was cemented in Q4 when Powell said the committee would need to see persistent inflation above the 2% level before even considering a change to short term rates.  

Corporate earnings faced tough 2018 comps and the S&P 500 is fresh off three straight quarters of negative earnings growth. According to FactSet, corporate earnings are expected to grow just 0.3% in FY 2019.  Economic data has been mixed but overall the economy seems to be holding on. While ISM Manufacturing PMI came in below 50 over its last four readings from August through November, Services has held up strong averaging 55.5 for all of 2019.  Unemployment is at 50-year lows and wages are rising at or above 3%. While businesses may have pulled back on spending and investment due in part to trade uncertainty, the U.S. consumer has been resilient and just registered the biggest holiday spending on record. 

Market performance:

The Nasdaq 100 and Nasdaq Composite led all major U.S. equity indices in 2019 by a healthy margin with gains of 38% and 35.2%. The next best performers were the S&P 500, +28.9%, R3000 28.5%, and S&P 400 Midcap indices, +24.1%. The Dow Jones Industrials and Russell Microcap indices finished at the back of the pack with gains of 22.3% and 21.0% YTD. While the overall breadth and participation was broad, the small cap Russell 2000 and Russell Microcap indices remain roughly 4% and 9% below their 2018 highs.   

In 2019 the Nasdaq 100 (NDX) outperformed the flagship S&P 500 by an impressive 9.1 percentage points, however this type of alpha is not a one off. 2019 marks the third time in five years the NDX has outperformed the SPX by at least nine percentage points. 

Over the last decade the performance of Nasdaq-listed companies has been even more impressive. Since 2009, the NDX has outperformed the SPX in ten of eleven years. Since 2010, the NDX and Nasdaq Composite indices have a total return of 425% and 347%, respectively. For comparison, the S&P 500 and Dow Jones Industrials registered total returns of 256% and 252%. Put another way, the NDX outperformed its large cap brethren by 170 and 174 percentage points over the last ten years. 

Underneath the hood most sectors performed well on both an absolute and relative basis. Technology (+48%) had its best year since 2009, while on the opposite end of the spectrum it was Energy (+7.6%) which came in last of the eleven GICS sectors for the second year in a row. Excluding the top (Tech) and worst (Energy) performers, the remaining nine GICS sectors had an average return of 24.9%. 

On a relative basis Healthcare (+18.7%) underperformed, however, it gained an impressive 13.9% in Q4 and let’s not forget it was the top performer in 2018. And over the last two years combined, Healthcare’s total return ranks 3rd out of the eleven GICS sectors.  

Rates, Commodities, & the Dollar:

Treasury bonds had their best rally since 2014 as global flows sought safe havens due to continued weakness in the global economy, uncertainty from trade wars, and a new round of easing by global central banks. The UST 2YR yield declined 92bps YoY and with it ended a streak of seven consecutive years in the green. The UST 10YR declined 77bps YoY for its biggest drop since 2014. The Fed’s three rate cuts help to reverse a deeply inverted yield curve. The below chart illustrates the widening of the curve from 6/30/19 (red) compared to the current slope (green).

The Bloomberg Commodity Index (BCOM) gained 4.9% in December and finished the year with a relatively modest 5.4% return. After declining 24.8% in 2018, WTI crude rebounded for a gain of 34.5%. Spot gold gained 18.3% for its best year since 2010, while copper rebounded over the final four months to finish with a modest gain of 6.3%. 

The U.S. Dollar Index (DXY) gained a modest 0.2% despite the heavily weighted (58%) EURUSD pair declining 2.2%. The JP Morgan Asian Dollar Index (ADXY) declined 0.2%.   

While the greenback’s moves were relatively modest, the technical setup in the EURUSD currency pair deserves our attention going forward. The narrow trading throughout most of 2019 has created extreme volatility compression. This can be measured by the spread between the upper and lower Bollinger Bands (weekly, 20, 2, 2) which reached a 40 year low in Q1’19 and remains close to those levels today. More recently in late November, the weekly Average True Range (ATR) reached a 23 year low. Both indicators are capturing the extreme “volatility squeeze” underway for quite some time now. John Bollinger notes periods of low volatility are eventually followed by periods of high volatility. High volatility does not indicate direction, but it does indicate a powerful move.  Therefore an extreme low in volatility can foreshadow a meaningful advance or decline in price. 

Global exchanges rebounded from an abysmal 2018 due in part to a lackluster dollar and an easing Fed which helped improve dollar liquidity for the rest of the globe. The era of negative rates in Europe appears to have reached exhaustion and there is hope new ECB President Christine Lagarde will steer the region towards a different path of easing measures to the benefit of the banking system. The de-escalation in the U.S. – China trade war also contributed to a rebound in global sentiment and asset prices.  

Looking Ahead:

Just three days into 2020 and the existing list of concerns are already growing. On the economic front, the just released ISM Manufacturing data for December posted its lowest reading since 2009 and suggests the slowdown in the U.S. economy may not entirely be in the rearview mirror. The U.S. responded firmly to last week’s attacks on its Iraqi embassy with targeted missile strikes killing a senior Iranian military officer. While a “phase one” trade deal is expected in the coming days, a new front with Europe is expected to open later this year. 

The latest headlines remind us that the unforeseen is a risk when looking forward. Still, geopolitics and U.S. domestic politics have largely been a sideshow as far as U.S. equity markets have been concerned. 

Even with these new risks – and probably a few more to develop – most investment firms polled believe that the global economic recovery will continue in 2020. Central banks renewed accommodative monetary policy support and resilience in consumer spending should help grow corporate earnings, fueling economic growth this year.

The Fed, trade, the economy and corporate earnings – in roughly that order – have largely been the driver of market gains in 2019 and developments in these areas, with some geopolitics thrown in, will be the focus as we enter 2020. 

Originally Posted on January 7, 2020 – 2019 Review and Outlook

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