2019 was a successful investing year with the major stock market indices all producing returns over 20%. Following such a year, the natural question is always can the markets do it again? 2020 is sure to be an interesting year as we face several dynamics including ongoing tensions with foreign trade, higher stock market values, and a presidential election. While no one can predict the future, we feel it is important to understand the current economic climate in order to make educated investment decisions for the first part of the year. This outlook is a summary of several analyst commentaries that we feel are helpful with our investment research.
The Economy
At Centered Financial we take a top-down approach to investing which means that we start with understanding broader economic conditions and then work down to how certain industries and companies may be affected. We feel that it is important to understand the drivers that affect business decisions in order to decide how to invest.
In December 2019, U.S. manufacturing activity hit its lowest level since the end of the Great Financial Crisis in 2009. This result shows that U.S. manufacturing continues to be contracting and is an indicator that trade tensions are continuing to impact the economy. Business capital expenditures were also sluggish in 2019 indicating that companies are hesitant to spend money with the instability in trade.
Along with the slow manufacturing and capital investment numbers, low unemployment and increased pressure on corporate profit margins has put our U.S. economy in the late phase of the business cycle (See the image below). That being said, most analysts are cautiously optimistic that the U.S economy will stay in this phase and continue to expand through 2020 instead of turning to a recession. The de-escalation of our trade war with China and the passing of the USMCA trade deal could bring some stability and lead to business confidence.
Consumers will also be a major factor in continued economic growth. Our strong labor market and low interest rates that keep debt servicing manageable have increased consumer confidence and created a narrative of strength despite some of the issues that we see in business production. As you can see in the images above and below, analysts put the global economy in the late phase of the business cycle however, continued growth is expected and consumer confidence is strong.
The analysts at LPL Financial research have provided expectations of 1.75% GDP growth in 2020. As you can see, they are also optimistic that economic growth will continue however at a slower pace throughout the year.
Political tensions leading up to the election in November are an outside factor with consequences that are difficult to predict. This additional level of uncertainty may contribute to business and consumer decisions this year.
Outlook for Bonds
Bonds provide an alternate asset class to stocks in our portfolios and in 2019 the bond markets performed better than expected. Bonds are very interest rate sensitive investments and in 2019 we saw interest rates fall. The result from this is that bond prices are driven up.
For 2020, the Federal Reserve is in “wait and see” mode, which means that we don’t expect them to take any interest rate action in the first part of the year. For the time being, we have made a decision to favor short to intermediate term corporate bonds and high yield bonds over government bonds. We have made some slight adjustments in our bond allocations for 2020. The changes provide reduced exposure to international bonds as we see U.S. bond yields increasing their gap above international yields.
Outlook for Stocks
With stock values increasing through 2019, the consensus among the research that I have read is that it is hopeful that corporate earnings grow to support the increased valuations. So far this month we have seen positive earnings reports and we expect that they will continue to be positive through the quarter. If corporate earnings continue to be strong, then stock performance should remain solid through the first part of this year, however we do expect increased volatility considering the economic headwinds discussed above.
Since we are in the late phase of the business cycle, we would expect that cyclical stocks would be the better performers. These are stocks in technology, financials, industrials, communication services, and consumer discretionary industries. The companies that led the way through 2019. If the economy slows further, then defensive areas like healthcare and consumer staples tend to be attractive. We are mindful that a lot can change throughout the year, especially with the backdrop of global trade and political tensions.
We have made slight adjustments through rebalancing portfolios to take advantage of momentum areas of the U.S. market. As always it is important to remain diversified among sectors and industries and maintain a long-term perspective.
Conclusion
While it is important to understand the nature of the economy and what is driving markets, the outlook for 2020 does not change our overall investment philosophy. It is always more important to focus on what you can control instead of what you can’t control which is why it is essential to have a process. At Centered Financial, our process is based on principles that enable you to invest with purpose to reach your defined goals. Long-term consistent returns are driven by:
Allocating your investment assets based on a strategic plan to reach your goals.
Choosing investments that are accessible through low-cost, efficient means that prevent additional drag on your returns over time.
Avoiding emotional mistakes by making investment decisions based on research and data.
Outlooks are interesting in that no one can really predict the future and we seldom get what we expect. We continue to monitor progress and will keep you informed on current events. Please visit our blog throughout the year to see the weekly market and economic updates posted on Mondays.
We look forward to a great 2020!