Q4 2019
January 6th, 2020
One thing you’ll notice in reviewing what we’ve sent, is the stock markets posted significant appreciation in 2019. I suppose as a stock investor, I should embrace these good years and just be happy. However, as an analyst I feel compelled to provide context to keep our focus on what is driving the markets. There is nothing new in what I’m going to say, just a reiteration of the variables important to the markets today.
The current market is favorable largely because the U.S. economy is performing well. Unemployment is at low levels, wages are rising, which provides a base for favorable spending and demand. These conditions were not a direct result of the tax cuts enacted a couple years ago, but the tax cuts strengthen the already good fundamentals.
I have said in the past that the corporate tax cuts will have a multi-year favorable effect on the economy and the stock markets. Even if we go into a recession in the coming years, all things will be better than they would have been absent the tax-cuts.
2017 was a very good year for stocks directly as a result of better earnings growth brought about by the tax cuts. As we moved into 2018, stocks continued to perform well and even moved higher as the Administration introduced trade tariffs. It all stopped in September 2018 when the Federal Reserve decided to start moving interest rates higher.
I have contended for years, that the Fed’s low interest rate policy should have ended in 2013/2014 when asset prices stabilized (post the Great Recession) thus ending their reason to hold interest rates so low; it didn’t. I believe the longer they hold rates low, the more disruptive the ultimate unwinding of this policy will be. We saw a glimpse of that from September 2018 into year-end 2018; the stock market fell as a direct result of higher rates. The decline accelerated into the end of the year.
When we look at the strong appreciation in stock prices in 2019, one thing to keep in mind is December 31, 2018 was a sharp low in stock prices. Reported numbers can be deceitful if measured over periods starting or ending on peaks or valleys in the market’s value.
Entering 2019, the market had just sold off, Wall Street was forecasting declining earnings for 2019, and the Fed was still talking about raising interest rates.
Then in response to the falling market, the Fed reversed course and decided the economy could not tolerate higher interest rates. They cut interest rates and indicated it was unlikely rates would be raised again any time soon. Stock prices began to recover as this major headwind was removed.
As important, the economy did not slow in 2019 and corporate earnings remained good.
Looking at the stock market’s performance from the beginning of 2017 up to the end of 2019, we see nice appreciation reflecting a good economy, and solid earnings. Stocks have not become expensive; they are merely reflecting favorable conditions.
The lesson of the past 2 years is that we eventually have to face the music with interest rates. Someday in the future, the Fed is going to have to raise rates and it will have a negative effect on the stock market. However, it is clear the Fed will not raise rates if it compounds a weakening economy or causes a significant negative impact on stocks prices. That means, when it happens it will be implemented in a measured manner that lessens the impact.
Moving into 2020, it would not be surprising to see the market give back some of 2019’s appreciation. There are plenty of short-term uncertainties including the election and the outcome of the trade negotiations, but that’s nothing new. There are always short-term uncertainties. Stocks are fairly valued based on expectations for modest economic growth, that is seldom the state of the market prior to a major decline. We remain favorably predisposed to the stock market.
I wish you all a very Happy New Year!
Mark Hoonsbeen
CFA, Principal