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The dominance of the stock market by a handful of companies continues. The 5 largest firms now comprise 18% of the capitalization of the market, far in excess of anything seen over at least the past 25 years.
Year in Review – 2019
The world endured an uncomfortable degree of political uncertainty, much revolving around US efforts to remake the world trading/economic order. Despite the apparent momentum behind populist leaders in several countries, corporate influence and profits remain at astounding levels. Despite much turmoil, conditions favor investors and the stock market’s strong result in 2019 evidences this.
The year was positive for the American economy and consumer, although growth slowed noticeably as the year wore on. Purchasing power gathered strength due to low inflation, and wages rose a bit faster than in previous years as unemployment fell to levels considered impossible just a few years ago.
The Federal Reserve responded to the market plunges in late 2018 and weakened business confidence with three rate cuts during 2019. The absence of inflation has prompted a re-think at the Fed and official optimism on this front has increased.
Major Economic Events
Growth in the US was tepid, continuing the extended expansion. The effects of the Trump corporate tax cut waned and growth slowed accordingly. Despite trade tensions and business uncertainty, employment expanded steadily, inflation remained under control, and housing prices rose. Consumer confidence remained very high, as evidenced by high spending. Profit growth stagnated, but margins remain at extremely high levels.
The global economy expanded but growth faded. Europe’s economic recovery stalled as several countries fell into recession and Germany’s growth ground to a halt. The British economy underperformed. Contrary to what most expected however, the interminable Brexit saga has not had a drastic effect on British and European economies. China’s growth continues apace but is far below the rate achieved during the past decade. The Chinese government has struggled to develop policies to manage the trade war’s impacts.
Commodity prices rose, although not nearly enough to kindle a widespread inflation. Military exchanges in the Middle East had little impact on prices, except for some ephemeral spikes.
The Equity Markets
Global stocks surged higher with a gain of 27%. Prices rose in every quarter. Investors shrugged off the trade conflict between the world’s two largest economies. As 2019 came to an end, both the US and China appeared exhausted from the conflict and news of a “cease fire” further catalyzed the markets. The other US-induced trade conflicts also failed to dent stock prices. Interestingly, the 2019 gains could be categorized as a triumph of hope over reality: Profits themselves were flat, albeit at extremely high levels.
The American stock market performed better than its international counterparts. International markets had a strong year, with gains of nearly 22%. That robust result fell short, however, of the astounding 31% from the US markets. Technology stocks were the standouts among sectors and growth stocks continued to outpace value. Despite what appear to be ideal conditions (low interest rates, supportive government policies), small cap stocks lagged. Many firms reported that the twin effects of tariffs and rising labor costs are hampering their business.
China’s markets were significantly impacted by the ebb and flow of the trade war. The news of a truce spurred a rally towards the end of 2019.
Natural resource stocks tracked the price of oil and ended 2019 with a positive result. REIT investors celebrated the cessation of Fed tightening and the fall in interest rates.
Overall, the effects of diversification from the traditional S&P 500 index were quite negative. Every major asset class fell significantly short of the S&P 500.
The Fixed Income Markets
It was a strong year for bonds. Prices rallied as the Fed signaled an end to tightening and interest rates for most bonds tumbled. The Fed followed through with three rate cuts and left little doubt rates will stay low for the foreseeable future. International bonds also rose, although at a more moderate pace. Cash and similar investments had benefited from the Federal Reserve’s increases in rates, and will now continue to drop in accord with Fed policy.
Stagnation in American manufacturing continues. ISM index falls to 48.1, below the "neutral" level of 50. Despite the resolution of the UAW strike, there was no improvement in November. I suppose when Boeing resumes shipping the 737 Max, the overall numbers will improve. But nevertheless, the effects of the trade wars and poor business confidence continue to manifest themselves in data.
Should we be alarmed that the Fed is cutting rates at a time when core inflation has accelerated? Core = inflation excluding food and energy. Although the inflation rate for September itself was quite low, I note that core inflation has increased steadily in recent months and is now at 2.4% year over year. It appears the Fed will remain singularly focused on combating the effects of the Trump trade war. We can only hope that inflation will remain well contained even with the return of (very) easy money.