An Impressive Year, A Rewarding Decade
In the classic historical novel written by Charles Dickens, “A Tale of Two Cities,” there is an oft quoted line that begins by stating, “It was the best of times, it was the worst of times.” This sentiment is an apt description of the decade that ended with the close of 2019. While the U.S. economy delivered positive growth throughout the period and financial markets delivered returns ranging from modest to exceptional depending on asset class, many investors did not seem to enjoy the journey. Their lack of enthusiasm may not translate into a feeling of the worst of times, but it certainly did not reflect a mood indicative of the best of times.
Using perfect hindsight, if we were in the year 2010 and communicated U.S. equity returns, as measured by the Russell 3000 Index, would deliver an annualized return of 13.4% over the next 10 years, it is hard to imagine anyone would not be positively giddy with such a result. Adding in equity markets outside the United States still yielded a return of 8.8%. And given the widely anticipated increase in interest rates and commensurate decline in bond prices that has been in place seemingly forever, a 10-year annualized return of 3.8% from the fixed income markets would also have been enthusiastically received.
So why weren’t investors more enamored with the results generated by financial assets in the decade? While we certainly do not hold ourselves to be experts in behavioral psychology, one explanation is the financial wounds from the market decline that occurred during the 2008-2009 recession never fully healed for many investors. This response to the financial crisis of 2007-2008 was supported by the numerous investment strategies and related products that were created as a reaction to the decline in asset values that occurred during the recessionary period, which focused on protecting investors from future market declines. To the extent investors added these strategies to their portfolios, the lower the resulting returns as many of these offerings lagged the returns provided by more traditional offerings. Add in the ever-present geopolitical risk, trade concerns and domestic political strife and a heightened level of apprehension and mental fatigue on the part of investors is easily understood.
As previously noted, the last decade was characterized by consistently moderate economic growth. Real GDP never achieved a calendar year growth rate of 3.0%, hitting the 2.9% threshold twice, in 2015 and 2018. As we move forward into the new decade, our outlook is for the moderate rate of economic growth to continue, prolonging the longest period of expansion on record. To quantify, real GDP growth is anticipated to register 1.8% in 2020 according to a survey of economists conducted by Bloomberg. The 2020 outlook from the Federal Reserve is slightly more optimistic with a projection of 2.0% for real GDP.
Globally, GDP is expected to grow 3.4% in 2020. This compares to a more modest level of 3.0% in 2019. This projection, from the International Monetary Fund, is based on an expectation of improvement in numerous emerging market economies while growth is anticipated to be somewhat slower in China and the United States.
The consumer will continue to play a major role in the U.S. economy in 2020. While recent measures of consumer confidence have shown mixed results, overall readings remain historically strong supported by a solid job market, real wage growth and a positive wealth impact from rising stock markets. Quantifying the level of consumer wealth is seen in the increase in household net worth from $71 trillion as of the third quarter of 2007, to an estimated $117 trillion in the fourth quarter of 2019. Also, employment is expected to remain healthy with little change anticipated in the unemployment rate.
Inflation is expected to continue to increase at a modest pace in 2020 with the Core PCE measure registering 1.9%, just under the Federal Reserve’s targeted level of 2.0%. Other measures, such as the Consumer Price Index, indicate a more substantial level of inflation and we will be monitoring these indicators closely, as well.
Monetary policy is not anticipated to be an economic headwind in 2020 as the Federal Reserve is currently buying $60 billion of Treasury bills monthly to boost bank reserves and ensure sufficient liquidity.
In summary, the expectation for the U.S. economy in 2020 is for more of what we have seen throughout this recovery: modest growth, modest inflation and a supportive monetary policy.
Asset Allocation Review and Outlook
Throughout the fourth quarter, we maintained our asset allocation positioning. Our overweight to equities continued to make a significant contribution to portfolio performance as stocks handily outperformed bonds over the three-month period. Both domestic and international equities turned in strong performances with the Russell 3000 Index of domestic equities returning 9.1% and the MSCI ACWI (ex U.S.) Index of global equities, excluding the United States, returning an almost identical 8.9%. Fixed income performance, as measured by the Bloomberg Barclays Aggregate Bond Index, returned an impressive 8.7% for the year, but as rates rose in the fourth quarter, the three-month return registered a much less robust 0.2%. Highlighting the excellent overall performance achieved as the decade ended is the fact that equity and fixed income markets had the strongest simultaneous gains since 1998.
In addition to the positive returns for the quarter, the investment environment was relatively calm as volatility was subdued throughout the period with the CBOE Market Volatility Index (VIX) beginning at a reading of 16.24 and ending at 13.78. To provide some perspective to these figures, the VIX began 2019 at a level of 25.42.
Currently we are continuing our allocation positioning with its emphasis on overweighting equities relative to bonds and favoring domestic equities over international markets. As always, we continually evaluate our asset allocation positioning to ensure it reflects our convictions regarding the overall investment landscape and the underlying asset classes comprising client portfolios.
Referring once again to text from “A Tale of Two Cities,” as we enter 2020 given our current outlook, we are focused more on the environment being a spring of hope as opposed to a winter of despair. However, given our strong commitment to risk management, we’ll keep a warm coat handy. Just in case.
Source: BTC Capital Management, Bloomberg LP, Ibbotson Associates, FactSet.
The information provided has been obtained from sources deemed reliable, but BTC Capital Management and its affiliates cannot guarantee accuracy. Past performance is not a guarantee of future returns. Performance over periods exceeding 12 months has been annualized.
The information within this document is for information purposes only and is not intended as an offer or solicitation with respect to the purchase or sale of any security. Statements in this report are based on the views of BTC Capital Management and on information available at the time this report was prepared. Rates are subject to change based on market and/or other conditions without notice. This commentary contains no investment recommendations and you should not interpret the statement in this report as investment, tax, legal, and/or financial planning advice. All investments involved risk, including the possible loss of principal. Investments are not FDIC insured and may lose value.