The long-term trend in the economy continues to be positive, with 2.0% growth in real GDP and inflation averaging around 2.0% expected for the year 2020. Last year there was considerable weakness in industrial and manufacturing businesses, while the consumer and service-oriented parts of the economy remained strong. The stock market is said to climb a wall of worry, and in 2019 the focus was on trade and the Fed. As progress was made in the trade negotiations with China as well as with Canada and Mexico, the market has responded positively. The risk of a major trade war is hopefully averted.
Corporate profits were little changed over the course of the year and there was no significant upward pressure on inflation and interest rates. This prompted the Fed to cut rates three times and reverse their actions to shrink their balance sheet. Going into the year the expectation was that they would raise rates three times, on the heels of their decision to raise rates in December 2018. Most central banks around the world are now acting to keep rates low to try to stimulate more growth. In the U.S., the labor markets remain strong and the consumer’s financial condition is better than it’s been in years.
The global economy has been in a slowing trend over the past year. This is the third time since the recession of 2008/09 that this has occurred. However, heading into 2020. there have been signs of improvement. Easier global monetary policy has lowered global short rates by half a percent over the past year and these lower rates are starting to spur a pickup in growth. Investor confidence has risen with the worst-case scenario of trade wars seemingly taken off the table and there is some hope that BREXIT issues are on course to finally be resolved. Hopefully this will spur a resurgence in CEO confidence, manufacturing and capital spending.
The housing market seems poised to improve heading into 2020, providing there is another boost to the economy. November housing starts were 1.36M (annualized rate), above consensus for 1.34M and higher than October's upwardly revised 1.32M. It’s also the highest level since early 2007. Single-family and multifamily starts gained 3.2% month/month and 13.6% year/year. November building permits were 1.48M (annualized rate).
With low mortgage rates expected to continue, a shortage of affordable housing, and consumer confidence in near record-high territory, housing should be another positive catalyst to the economy.
Common stock valuations rose throughout the year, with interest rates declining and little to no earnings growth. The demand for bonds remains surprisingly strong, even at very low interest rates, while the net flows out of equity funds continued. We expect interest rates to remain near the current level and moderate profit growth. This investment environment should continue to be rewarding for equity investors, but a difficult one for most fixed income investments.
A year ago, investors were unsettled by the sharp decline in stock prices during the fourth quarter of 2018. While profit growth had been much better than expected, aided by the tax cut, there were growing worries about the possibility of a recession with the rise in rates and the trade issue uncertainties. This created the opportunity for the rise in the market to all-time highs over the course of 2019, as confidence increased and interest rates declined.
Of course, there remains plenty to worry about as we await Phase 2 of the China trade talks, the upcoming elections, conflicts in the Middle East and other geopolitical risks. Interest rates remain low, continuing to provide a challenge for fixed income investments. Once again we are reminded that short-term market movements are unpredictable, but that fact provides opportunities for investors.
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