A Decade to Remember
January 21, 2020
The 2010 thru 2019 decade was the first decade in United States history not to have a recession. Let me reiterate what I just said; From our country’s founding, this was the first decade in which we didn’t experience a recession. We also experienced the highest S&P earnings growth in history. These are remarkable statistics. Even though the S&P 500 had tremendous growth during the decade, a 289% price return was not an easy one for investors to navigate.
While the markets did appreciate from 1,115 to 3,230, the 289% return I mentioned above, the markets spent the first third of the decade recovering loses experienced in the Great Recession. On March 28, 2013, the S&P 500 finally had retraced its losses and recovered where it was in October of 2007, at 1,565. It did so in the face of the “flash crash” of 2010 and the United States losing its AAA credit rating. While the decade did provide a 289% return, an investor back in October 2007 only experienced a 106% return, as they spent six years losing money or recovering the loss, and what would be considered slightly below-average returns over a 12-year period (approximately 8.65% average annualized returns).
Since it is hard enough to remember last week, I thought it might be fun to highlight a few things that happened in each year of the past decade. Here are a few things:
- 2010: 12.78% return for the year. The Flash Crash hit on May 6th, sending the Dow Jones down more than 1,000 points (over 9%) in just ten minutes. Circuit breakers fail to go off. Markets drop over 16% between April 23rd and August 8th. The Deepwater Horizon oil rig explodes, spilling millions of gallons of oil into the sea.
- 2011: 0.00% return for the year. On July 2nd Moody’s and S&P downgrade U.S. Treasuries from AAA to AA+. Navy Seals killed Osama Bin Laden. The Space Shuttle program ends after 30 years.
- 2012: 13.41% return for the year. Despite the uncertainty caused by the “fiscal cliff,” a presidential election, and slowing global growth, the S&P 500 had a very good year, shrugging off a 10% intra-year decline. Hurricane Sandy hits New Jersey and New York, causing $65 billion in damage. Barack Obama is reelected as President of the United States.
- 2013: 29.60% return for the year. The S&P 500 shrugs off a “fiscal cliff,” sequestration, and a government shutdown to post its strongest performance since 1997. There were no corrections during the year, with a 6% pull back being the largest decline. Edward Snowden leaks highly classified documents from the NSA. Terrorists attack the Boston Marathon.
- 2014: 11.39% return for the year. Third double-digit positive year for the S&P 500. This is the first time this has occurred since the late 90’s stock market run. There was no correction this year, and two minor pullbacks of 5%+, with the longest losing streak being only three trading days (the shortest ever). The Affordable Care Act goes into effect. The markets shrugged off fears that the Ukrainian civil war might spread to Europe. There was also the Ebola pandemic fear. While the Ebola outbreak was horrible to those involved, it never spread into the world-wide pandemic people feared.
- 2015: -0.73% return for the year. A very tough year in the markets. Not one of the 12 assets classes produced a double-digit return for the first time since tracking them. Much of the downward pressure on the market was due to “the great fall of China,” the Greek debt default, and oil’s price slump.
- 2016: 9.54% return for the year. Even though the markets gave us a historically average year, the year was a rollercoaster year. January was a horrible start to the year, as investors thought that record low oil prices might cause many of the oil fracking companies to go out of business. Fear then spread to the financial industry, which had lent money to the oil industry for their fracking operation. June brought us Brexit, and once we recovered from that, the markets turned south ahead of the presidential election. The markets rallied through the end of the year. The Chicago Cubs won their first World Series since 1908. Donald Trump was elected to become the 45th President of the United States.
- 2017: 19.42% return for the year. For the first time ever, the S&P 500 did not experience a single negative month during a calendar year. The S&P 500 went 14 months without a decline, second longest ever. The year will also be remembered for record low volatility and increased global tension, especially with North Korean leader Kim Jong-un. The “#MeToo” movement begins after Harvey Weinstein is accused of sexual harassment.
- 2018: -6.24% return for the year. After a fantastic January, February’s drop gave it all back due to investors’ concerns about wage increases and the potential inflationary impact it might have on the economy. The markets fought back and rose until the 4th quarter of the year, when fears about an inverted yield curve, our trade war with China causing a recession, and the Fed raising rates drove the S&P 500 down 20% from its highs on fear of a 2019 recession. Former President George H.W. Bush dies.
While the markets had hit their bottom on December 24, 2018, and had recovered some of the 19.9% correction, we started 2019 with a lot of uncertainty. The U.S. Government was shut down. It went through the longest government shutdown in its history, closing for 34 days (December 22, 2018 through January 25, 2019). Fear of a global recession was ramped. Yet twelve months later, the S&P 500 rallied 28.88%, experiencing its second strongest year in the markets since 1997. Even though 2019 was a historically strong year, most of the year was spent recovering what was lost in 2018. As you can see from the chart below, the S&P 500 finally broke out and above its previous highs (the red line) in October of 2019, on news that a partial trade deal with China had been agreed upon.
What we like, going into 2020
The Secular Bull Market
Our secular bull market, which started in 2013, is well intact. If you remember from previous writings and events, the average secular bull market has historically lasted for 14 years, with the shortest being 9 years. While every secular bull market is different, we expect the markets to push ever higher for several years to come. As we’ve also discussed, that doesn’t mean the markets go straight up or that there aren’t recessions along the way. Look at the 1982 through 1999 secular bull market. We had the 1987 stock market crash and the 1990 recession during that time. The long-term trend was intact for 18 years. We don’t see any reason why our secular bull market will come to a screeching halt and set records for the shortest of all time. We would expect the trend to run well into this decade.
Our Economy Is Fine
Since the recovery from the Great Recession, the United States’ economy has grown by 2.3%. This is slightly lower than our 50-year 2.7% GDP growth average. Our economy is growing at 2.1%. While this is not a fantastic number, it also isn’t recessionary nor looking like it’s heading in that direction.
Leading economic indicators, which have alerted investors of pending recessions for over sixty years, have flattened but have not turned down, nor are they flashing any signal of a pending recession.
This is further illustrated by looking at how our current economic expansion has been compared to all other post- WWII economic expansions. As you can see from the chart to the right, our economic expansion is illustrated by the light blue line. As you can see, our economic expansion has been longer than any other, but it has only outpaced two other expansions of this era.
Earnings Look Good
Analyst expectation for 2020 corporate earnings look good, especially for the second half of the year. The chart to the right provides Q4 2019 through Q3 2020 earnings expectations (highlighted in green). While it may appear that the next two quarters are flat, compared to our most recent earning reports (Q3 2019), you must look at where earnings were four quarters prior. In each case, earnings are expected to be stronger than where we were a year prior.
The Fed is Being Patient
Part of what derailed the markets in 2018 was the fear that the Fed would raise rates without truly understanding the impact their actions were having on the economy. They raised rates four times in 2018 and then reversed their trend by lowering rates three times in 2019. Typically, the Fed raises rates to combat inflation, which typically slows the economy. As you can see from the chart below, the Fed has rates at 150 bps. Futures show the highest probability for the next year is to see one 25 bps cut in rates. If we don’t see that, they probably will do nothing during the year.
We Have Low Inflation
There are two ways of measuring inflation. There is the Producer Price Index (PPI) and the consumer price index (CPI), with the latter being the more widely used as it impacts the general public. As you can see from the chart below, our current CPI levels are historically low and do not point towards any near-term inflationary pressures.
The U.S. Dollar
The value of the dollar is a double-edged sword. On the one hand, if the dollar strengthens too much, our products become more expensive to sell abroad, and as a result, we sell less of our goods overseas, negatively impacting our economy. On the other hand, if we have a weak dollar, the American people lose their buying power abroad. The chart to the right shows that the dollar’s value has not changed much over the past year and a half. A stable dollar eliminates one variable that can impact domestic companies and their earnings.
Unemployment at Record Lows / Wages Increasing
Every so often, investors get the “jitters” when news of wage increases hits the media. I find the disconnection humorous. First, unemployment and wages are negatively correlated. Think of it in simple terms; if our country has high unemployment, you don’t have much leverage asking your boss for a raise. If you can walk across the street and find a better paying job, then you have the leverage to get higher pay at your current job, should you request it.
Right now, the national unemployment rate is 3.5%. 50-year lows. The only people not working right now either don’t want to work or are geographically dislocated from where they can find work. Either way, wages are increasing at a 3.7% annual rate. This is still lower than the 50-year average of 4%. Even so, the average American is making more money. What do you think they are going to do with their newly found raise? That’s right… spend it. 70% of our economy is based on consumer spending. If we are putting more money into the hands of the average American, the economy will remain stable and might even grow faster than what most people are predicting. Source:
International Is Looking Attractive
There are a lot of ways to evaluate markets. Price-to-earnings multiples is a simple but effective way to look at it. If you want to look at just P/E ratios, international companies look much cheaper than U.S. companies. Obviously, companies can be trading at a cheaper level for many reasons, and you don’t want to simply buy the cheaper investment without significant research. But it is something that we will be evaluating throughout the year.
Concern Points for 2020
Manufacturing is Contracting
According to the Institute for Supply Management, the latest manufacturing numbers are not looking good. When the Purchasing Manager Index dropped below 50, it indicated a contraction in U.S. manufacturing. As the United States economy has matured from being a manufacturing economy to a service economy, PMI has become less useful as a predictor of a recession. December’s PMI level of 47.2 is concerning, as is the direction it seems to be heading. While this is a concern point, we won’t become too concerned unless it crosses the 45 level.
Valuations Are a Little Rich
The S&P 500 and the Russell Investment Group indexes are not cheap, based upon their historical averages. To the right is a chart showing the Russell Indexes and how they are trading based upon the 20-year average price to- earnings ratio. Only small-cap value is trading below its historical average.
Does this mean that the markets are due for a correction? No, but it is a concern point and it is something that we will be keeping a close eye on during 2020, or until they are trading at proper or below-average levels.
You’re Losing Money Buying Treasuries
The U.S. Treasury yield curve has flattened as short-term treasuries yields have gone up due to Fed action, and intermediate and longterm bonds have dropped in yield due to foreign demand (remember with bonds, as price goes up, yield goes down and vice versa). Regardless, much of the yield curve falls below current inflation rates. This means that you are losing buying power.
As you can see from this chart of historic 10-year Treasury yields. There is the nominal yield, what you see as the going rate. Then there is the “real yield,” which is the nominal yield minus inflation. Right now, the 10-year Treasury is providing you a -0.40% real yield, meaning that you are losing about a half a percent per year by owning the 10-year Treasury. And you’ve locked in that wonderful rate for the next 10 years. If you bought $100,000 of 10-year Treasuries, you’d be able to buy $96,000 worth of goods in 10 years, assuming that inflation didn’t go higher or lower. Given that inflation is well below historical norms, you run the risk of buying even less in 10 years.
An Impeachment Trial
As you probably already know, a simple majority in the House of Representatives is all that is required to impeach a president. That’s where we are at this current time. The procedure then moves to the Senate where a “trial” is held to determine if the President has committed a crime. The Chief Justice of the Supreme Court presides over the trial. It requires a two-thirds vote of the Senate to convict.
If you look at this from an unbiased, non-political standpoint, it is improbable that Donald Trump will be removed from office. The Republicans control the Senate, holding 53 seats, Democrats hold 45, and 2 are Independents. Let’s say that the 2 Independents voted with the Democrats, bringing their numbers up to 47. In order to remove President Trump from office, 67 Senators would have to vote to convict him. Is it realistic to expect 20 of the 53 Republicans to vote against a Republican President?
An Impeachment trial does add to uncertainty in the markets. We will be watching the proceedings to determine if there is any change to our portfolio that will be necessary to offset any increase or decrease to risk.
Presidential Election Year
There is nothing wrong with Presidential Election Years. They just tend to be more volatile years due to the uncertainty of what an election might bring to the markets. We monitor all election activity to understand the front runners, their platform, their probability of winning, and how their platforms might impact the markets.
Escalation of Global Tensions
There are a number of hotbeds that could trigger more than a drone strike if things were to escalate. Tensions are rising with Iran. North Korea could quickly escalate into war. Iraq, Syria, Afghanistan, and Venezuela are ripe for a flare up… or worse. While less likely, things are not great between the United States and China, nor are things great with Russia.
We are not reactionary to global tensions, as it seems every year like there is some possible issue that could turn into an actual conflict. That said, we constantly monitor global tensions to make sure we understand what might be rhetoric and what might escalate into something more.
Trade War with China
Phase one of the new trade deal with China is to be signed on January 15th. Don’t get me wrong, I’m happy that things are moving forward. But I’m also a skeptic. While this is a great start, there is a lot that could go wrong, and we are far from the finish line with the Chinese. I have a lot of questions. When do we have a full trade deal in place with the Chinese? Will they adhere to it? Could this all fall apart? If so, what would the markets’ reaction be to new tariffs?
2019’s market movement was driven by the Chinese Trade War. I think the markets will continue to be very sensitive to the ongoing trade war negotiations until a full resolution has been signed by both sides and we have a few years of adhering to the treaty under our belt.
I don’t pretend to have tomorrow’s newspaper. What I can tell you is we try to stay in front of as many of the issues as we possibly can, while not allowing ourselves to be spooked out of the markets at the first hint of danger. This is what tactical investment management is all about. Being clinical with the decisions that we need to make, and making those decisions based upon risk to your portfolio. At the moment, we are cautiously optimistic about this upcoming year. Obviously, we’ll keep you informed with what truly happens this year as it happens.
As always, I welcome your questions and comments, and I encourage you to meet with your Polaris Greystone wealth advisor to keep up to date with our service offering.
Jeffrey J. Powell
Managing Partner, Chief Investment Officer
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