We normally hear some of these common questions:
I don’t have a crystal ball so I can’t time the markets (quick tip: no one else does!).
That said, over the long-term investors in stocks have been well rewarded for investing. Whether to invest also depends on your personal situation and when you’ll need the money. Although I don’t have a crystal ball, below is our 2020 outlook that discusses what happened in 2019 and thoughts on the future.
As noted in Exhibit 1, 2019 was an excellent year for stock and bond investors. As a reminder we started 2019 following an ~20% decline in the stock market in the 4 th quarter of 2018. There was also significant concern regarding a potential recession, trade war and geopolitical concerns. Very few predicted material gains in the stock and bond markets, but that is the challenge of short-term predictions.
Overall, the last ten years has been an excellent time to invest in large US companies (S&P 500) with an approx. 13.6% return. It may be easy to think all you need to do is invest in the S&P 500, but many forget that during the 2000s the S&P 500 returned -0.1%. We discuss the benefits of global diversification further in our blog post titled, The 2010s: A Decade in Review, but a good chart below (Exhibit 2) showing the differences in returns from the 2000s and 2010s by major equity asset classes. You’ll notice how the winners one decade are typically the losers in the next. In 2010 the common question was why invest in US stocks? Ten years later that question is now why invest in foreign stocks? The answer is over the last twenty years an investor was rewarded for a well-diversified portfolio of US and foreign stocks, rebalanced regularly would have resulted in higher returns than picking one market as noted in Exhibit 3.
At Financial Symmetry, we meet regularly to review different short-term and long-term market indicators to determine the appropriate investment strategy for all our clients.
Below is a brief summary of the current state of a few categories as of the beginning of 2020.
Global economic growth remains below historical levels as concerns remain regarding trade tensions, Brexit, the US presidential election and geopolitical concerns. Although unemployment and inflation remain low in the U.S. overall GDP growth remains below historical levels as noted below with 2.1% growth in the 3 rd quarter of 2019. We did see an inverted yield curve in 2019 which has been a consistent indicator of predicting recessions six to eighteen months out, but some would argue current low rates make this time different. Only time will tell. See exhibit 4 below of historical U.S. Real GDP and the key Components of GDP.
The looser monetary policy by central banks around the world will likely persist in this environment of low growth and low inflation. Market-implied probabilities still slightly favor a U.S. rate cut vs. increase in 2020 but will depend on economic conditions. One benefit of this policy is lower mortgage rates which means it may be a good time to consider refinancing your mortgage if over 4%.
Given the strong recent returns of stocks and low unemployment, consumer confidence remains near the highest levels of the past 20 years. Positive sentiment can drive short-term markets as we saw in the late 90’s but can have a material negative impact when/if it turns. Furthermore, a longer-term measure of sentiment is U.S. households’ exposure to equities. When exposure is high vs. historical standards future 10-year U.S. stock market returns are low and vice versa. Currently, U.S. households have nearly 54% of their assets exposed to stocks, which is in the highest quintile historically – the quintile with the lowest (although still positive) average subsequent 10-year U.S. stock returns. The last times households held this % of stocks were in the late 1990’s and mid 2000’s.
History has found certain periods have resulted in higher/lower returns than others. Part of this can be explained by starting valuation. Valuation is one of the best indicators of long-term returns (i.e. 10 years), but it is a horrible short-term timing strategy. One popular valuation metric we’ve discussed in the past is the cyclically-adjusted price-to-earnings (CAPE) ratio. Instead of dividing price by the past 12 months of earnings, the CAPE ratio divides price by the average inflation-adjusted earnings of the past ten years. The idea is to smooth out the good and bad years created by the business cycle.In addition, Exhibit 5 below is the average future 10-year real return based on starting U.S. CAPE Ratio. As of December 31, 2019, below are the current CAPE ratios of the major equity markets:
Exhibit 5The summary is current stock valuations favor the international markets.Regarding bonds our belief is that high quality bonds in your portfolio provide the following benefits: