IN THE BUSINESS OF INVESTING OTHERS’ HARD EARNED MONEY, it is amazing how some things change nearly overnight while others seem never to change. Even more amazing is how wrong the forecasters usually are each year. A little more than 12 months ago, we were looking back on a rather dreary 2018. Most stock indexes had lost ground as fears of additional rate increases by the Federal Reserve, rising trade disputes, slowing global growth and additional discord in Washington sent stocks sharply lower in the fourth quarter of 2018. Most forecasters expected rate hikes and anemic stock returns in 2019.
A year later, the forecast looks a little brighter, with eye-popping stock price increases and interest rate decreases in 2019 surprising almost everyone. While part of last year’s increases were simply recovering from December 2018’s plunge, equity returns are still great, especially in light of the decade-long rally from the market bottom of March 2009. For bonds, markets rotated from expecting three rate increases in 2019 to witnessing three rate cuts. All the while, the U.S. economy is the envy of the world, unemployment is near 50-year lows, consumer confidence is high with household income at the highest level in 20 years, and trade disputes seem to be lessening — at least for the time being.
However, some things have not changed. Global growth is still dreadfully slow, the European banking system is on life support, the European Union must still deal with Brexit and other problems too numerous to mention, China is slowing and the Japanese economy is still just hoping to emerge from three decades of being stuck in neutral. While some progress has been made on trade issues, we caution that significant issues must still be hammered out. The discord in Washington has probably been worse in the past, but it’s hard for most of us to remember when. And while the U.S. consumer has been spending, business spending continues to be lackluster as companies are still trying to navigate the uncertainties of the global economy.
We do not intend to inundate you with forecasts, but instead we will point out developments the investment team at First Merchants will be closely monitoring. Never have we taken for granted the trust our clients have placed in our team to serve as stewards of their wealth. Clients often mention how times seem to be more uncertain than in the past; however, in our team’s collective century of investment management experience, never can we remember a time when there was not a long list of uncertainties.
We have seen some recent progress on both the North American and Chinese trade disputes, but trade issues will continue to be an issue for not only months but also years ahead. Global trade is extremely complicated with a myriad of issues involved, making it difficult to base individual buy and sell decisions on any one outcome. While trade wars are not good for economic growth and are a definite headwind, in the U.S. they are not expected to shave more than a few tenths off GDP growth or push the U.S. economy into a recession.
GLOBAL GROWTH & INFLATION
We do not expect trade or geopolitical issues to go away in the foreseeable future as global growth and inflation are likely to remain lower for longer. As we enter 2020, the global economy shows some early signs of stabilization. Inflation is expected to remain muted for years but, looking forward, we will be concerned with debt escalation in many countries
and companies and the possible effect on inflation. Trade and political uncertainty will remain a drag on business demand. Europe continues to have a long list of problems that cause significant concerns. Continued economic and social issues will affect both financial and political institutions as Europe struggles with anemic economic growth, high debt, a shaky financial system, immigration and the social needs of an aging population. The European banking system continues to be very fragile and unprofitable. Globally, banks have announced plans to cut about 78,000 jobs, and 82% of that total is from European banks.
While politics do matter and do influence markets in the short run, even major negative political events (like the impeachment of a president) seldom cause more than a few months of hiccups in the overall stock market. Patient investors can do well in election years but should brace for market volatility. A look at history shows that presidential elections have made essentially no difference in long-term investment returns. Elections do have the potential to affect certain industries(i.e. health care or banking) or specific company stocks for longer periods. Historically, equity returns have been the best in periods when the federal government is not controlled by one party. Current indications are the 2020 election will prolong the divided government—and will remove some uncertainty.
U.S. MONETARY POLICY
Although most believe the Federal Reserve will be “on hold” during 2020, it is certainly possible it may feel pressured into further rate cuts if growth falters. In countries where monetary policy is already very loose, we may see some type of fiscal stimulus. Although manufacturing is still important, the U.S. consumer is the powerhouse behind U.S. economic growth and a major factor in our constructive outlook.
EASY MONEY/DEBT PRESSURES
Easy money policies around the world have certainly led to increased risks in the financial system. Low rates have caused investors to reach for yield, leading to stretched valuations in some assets while also encouraging both consumers and corporations to take on higher debt loads. Any economic or market downturn could be magnified as debt holders or ill-advised investors scramble as times turn against them.
As you can see, we expect many factors to influence markets in 2020. We know there are matters we can control and those we cannot, and we recognize the need to separate the short-term “noise” from the significant events that have long-term implications.
We will continue to focus on individual companies with management teams that have historically used shareholder capital efficiently and continue to build high quality balance sheets, pay sustainable dividends, possess pricing power, and have strong cash flows and underlying earnings growth capable of weathering an economic slowdown. We expect companies more dependent on consumer spending to be more stable than those dependent on business spending.
We will also continue to look further out than next quarter’s earnings to attempt to identify the long-term trends that can revolutionize economic or industrial sectors and determine long-term winners, such as the effect that artificial intelligence can have on individual companies. Additionally, we will continue to monitor the massive changes in energy production and how things are powered and the resulting impacts on many industries.
While we remain cautiously optimistic on the prospects for the U.S. economy and the equity markets, we also want to stress investors should expect subdued returns and bouts of volatility that might rock those without a solid and reasonable long-term financial plan. Numerous studies have shown the average investor has realized returns far worse than the average mutual fund, primarily as a result of jumping in and out of the market at the wrong time. A good long-term plan that puts emotion aside and focuses on long-term goals is the surest way to avoid this result.