Just to refresh our memories, at the close of 2018, investors were feeling a little different than they are today. The S&P 500 lost over 13% for the 4th quarter with a particular sharp drop of +9% in December. Investors feared the Fed would continue to raise rates and choke the economy. However, by the end of the 1st quarter, the Fed had announced a more dovish tone and the markets pretty much gave investors back their 4th quarter losses.
So we started the year with a positive quarter and, for the most part, continued to move up for the remainder of the year. As has been the case of late, large cap domestic stocks led the rally with the S&P 500 returning 31.5% by year’s end. This means the Index has risen more than 188% over the past 10 years, quite an accomplishment. Small cap and international stock investors shouldn’t complain, though, with small cap stocks gaining 25.5%, international developed market stocks returning 22.0%, and emerging market stocks climbing 18.4%.
Bond investors also had something to cheer. Due to the Federal Reserve reversing course and cutting rates three times during the year, bond values appreciated as well. Core bonds generally were up over 4%, with shorter maturities gaining less than longer maturities. High yield and emerging market bond investors were also rewarded earning 14.1% and 13.5%, respectively. During the year, we saw the yield curve invert, which portends a coming recession, but before the year’s end, the curve returned to a positive slope with 2 year Treasuries yielding 1.57%, 10 year Treasuries yielding 1.92% and 30 year Treasuries yielding 2.39%. These yields were off last year’s closing yields by about ¾% to 1%, in line with the rate cuts and an expectation of more to come.
Real return strategies had an impressive year as well. Because of the drop in interest rates, real estate investors were handsomely rewarded with values surging 28.7%. Infrastructure investors also enjoyed sizable gains of about 27.0%. Commodities, while not keeping pace with real estate and infrastructure, saw prices rise 7.7%. Within the group energy prices were mixed, oil surged over 30%, but natural gas declined about 25%. Crude oil production in the US is now close to 13 million barrels per day, keeping America the world’s largest producer of crude.
Absolute return strategies, which serve to reduce equity risk, highlighted by their overall rise when the market declined last December, produced returns which varied greatly among the strategies which is to be expected given their differences. Global macro strategies produced nearly double digit returns; whereas, market neutral strategies lost value. Overall, the returns were in line with bond returns with the group producing growth of close to 4%.
So, overall a good year for all asset classes — almost a complete reversal of last year which saw over 90% of asset classes lose value. All of this in a year in which economic and political risks increased. Globally, growth has slowed. Germany avoided a recession, but growth in the region remains anemic and Brexit remains a concern. China’s growth officially slowed to 6% and the government is reducing taxes and adding stimulus to avoid further declines. Japan’s growth remained positive in the 3rd quarter, barely, but a 25% increase in the value added tax at the start of the 4th quarter could make growth difficult for the final quarter.
In the US, GDP growth remains positive, unemployment is low, and job growth continues to be healthy; however, the Fed did not cut rates because the economy is strong and signs of weakening persist. Despite the surge in prices, S&P earnings were basically flat. This contrasts with last year’s earnings growth of +20% while the S&P declined. Taken over the course of the last two years, earnings have been responsible for the market’s gains.
Political risks increased during the year. Although North Korea stayed quiet (until year’s end), Iran heightened tensions in response to the dire effects the oil embargo’s reimposition is having on its economy. While there were several tanker attacks, a shoot down of a US drone, and missile attacks on Saudi oil facilities, no military conflict ensued. However, after the year’s close, the US killed General Suleimani, commander of Iran’s Revolutionary Guard. We’ll have to wait and see how Iran responds.
While trade war tensions peaked in the 3rd quarter anxieties diminished as the year closed with the US and China reaching what is being called Phase 1 of a trade agreement. In Phase 1, the US has agreed to cut the tariff rate on $120 bn of goods imposed in September to 7.5% from 15% and in return China will also lower tariffs, strengthen intellectual property rights protections, increase imports of US goods by $200 billion over the next two years and open up its financial sector to US firms. This removes the threat of further tariffs. To be sure tariffs have had an adverse effect on the economic growth in both countries. In the US, the drag on GDP is estimated to be about .5%, in China, about 1%. In our next video we will discuss how our two economies differ.
So investors enjoyed a stellar year and we ended on a positive note. Along with our investors, we celebrate these gains; however, as always, we stress caution. Over-exuberance can lead to excessive risk taking and a lack of prudence. For most, investing is a long-term endeavor replete with incredible gains and unfortunate losses.
Washington Trust Bank believes that the information used in this study was obtained from reliable sources, but we do not guarantee its accuracy. Neither the information nor any opinion expressed constitutes a solicitation for business or a recommendation of the purchase or sale of securities or commodities.
Washington Trust Bank.