Week 2 Sitrep

Quick note: Most of this letter was written on Monday, January 6th, and the geopolitical events with Iran were unfolding at the time of writing. We will provide more analysis of that situation in letter for January 13th. We don’t believe the current news warrants any urgent adjustments in portfolios.

 

Welcome to 2020! Having taken a few weeks respite from writing the Weekly Sitrep, we find a lot of material to share in order to catch up. The first thing is to acknowledge that 2019 was an incredible year for nearly all investment markets. Our goal in this letter will be to summarize markets in 2019 and provide a brief glimpse of where we are focused in 2020 for investment markets. If you like to read the last chapter of the book first, our analysis says the U.S. stock market is healthy with moderate expectations for corporate earnings growth and valuations that are slightly above the long-term average.

Source: J.P. Morgan Asset Management, Weekly Market Recap, 1/6/20

 

The S&P 500 Index had a banner year posting a total return of 31.5%, nearly three times the historical 12-month average return of 11.7%. The index experienced a strong turnaround from the 4th quarter of 2018 and continued to record new highs into the last week of the year. Despite the weaker return for the S&P 500 in 2018, the trailing returns for the index are better than average across all time periods except the 20-year return – which is still below average.1 Most investors will recognize the weaker 20-year time period includes both the 2008 and 2002 bear markets.

Source; Bespoke Investment Group, A Banner Year for Equities, January 2, 2020

 

We discussed most of last year that large companies with growth characteristics were the best performing area of the market. The rest of the market performed quite well but couldn’t match the strength of large growth companies. 2019 was an exaggeration of the last 10 years of market returns – growth companies have been the best performers since the last bear market in 2007.2

Source: J.P. Morgan Asset Management, Guide to the Markets, 12/31/19

 

The long-term uptrend for the S&P 500 Index reflects a 378% return since the bottom of the market in 2009 marking the second longest bull market in U.S. history. The 20-year return mentioned above includes bear markets of -49% and -57% along the way. This period is marked with below-average inflation for the U.S. economy while both consumer spending and housing have been strong.3

Source: J.P. Morgan Asset Management, Guide to the Markets, 12/31/19

 

While large growth companies have been the best performing stocks since March 2009, the technology sector has shown significant outperformance during the same time. The technology sector has grown more than 700% since the market bottom in 2009. As a result, the percentage of the indexes now represented by technology stocks has reached significant proportions. At the end of 2019, the technology sector represents 23.2% of the S&P 500 Index. Another 14% is represented by the communication services sector, which has several “technology-like” companies. For comparison, the energy sector now represents only 4.3% of the S&P 500 Index.4

Source; Bespoke Investment Group, Pros and Cons, December 31, 2019

 

The overall length of expansion in the U.S. economy since the bear market in 2008-2009 is the longest on record at 126 months. However, the magnitude of growth for this expansion is somewhat lacking. Relative to other expansions, this is the weakest period of cumulative GDP growth for all periods dating back to 1948.5

Source: J.P. Morgan Asset Management, Guide to the Markets, 12/31/19

 

We have often commented that the two primary drivers of stock prices are expected future earnings growth and the valuation investors assigned to such earnings (P/E multiple). For 2019, earnings growth was a bit weaker than 2018 although better than analysts were expecting. That would mean that most of the gains in stock prices for 2019 resulted from rising P/E multiples (read: valuations).6 This is important because it begs the question as to whether U.S. stocks have become too expensive. While P/E multiples are higher than average over the last 25 years, we do not believe they are beyond reasonable given current inflation expectations, interest rates and stock earnings growth.

Source: J.P. Morgan Asset Management, Guide to the Markets, 12/31/19

 

Our supply/demand indicators continue to show increasing demand for U.S. stocks. By way of reminder, we use these measures to determine the overall direction of trends for U.S. stocks, international stocks, bonds and a few smaller sectors. The long-term indicator is built using multiple metrics to gauge the overall demand for stocks while the “indicator value” helps us to visualize daily changes in direction and strength. The current indicator for U.S. equities at 73.36 is up from 44 in December 2018. We confirm the demand trends by looking at multiple time frames, as well as looking at individual asset classes and sectors within the U.S. market. If one of the indicators were to change to a negative position, our investment committee would commence an evaluation of portfolio risk to determine if a reduction in risk were warranted.

 

We continue to watch interest rates closely with the signing of a Phase One trade deal with China and the recent geopolitical risks. The Federal Reserve has indicated they will remain passive in 2020 “waiting to see significant increases in inflation” before considering a rate hike.7 The U.S. interest rates have remained range-bound with the 10-year U.S. Treasury opening 2020 near 1.80%. The 30-year fixed rate mortgage continues to support new home purchases just below 4%.

Source: J.P. Morgan Asset Management, Weekly Market Recap, 1/1/20

 

U.S. stocks remain attractive on a risk/reward basis according to our investment committee. While the internal measures of growth for stocks have slowed moderately in the new year, we believe that risk is slowly rising in equities. Thus, we will need to monitor our asset allocation model for asset classes that are getting too expensive or expect slower growth. At this time, the evidence supporting higher stock prices is reflected in the cumulative advance/decline line as well as the pattern for the 200-day moving average line.8 Both are technical indicators reflecting the nature of rising stock prices for the short term. We will look forward to discussing more about risks present for 2020 in the next few weeks.

Source; Bespoke Investment Group, Pros and Cons, December 31, 2019

Source; Bespoke Investment Group, Pros and Cons, December 31, 2019

If you’d like to schedule a time to discuss your portfolio or the markets in detail, please feel free to call our office at (281) 616-5935 or send an e-mail to cameron.malott@engravewealth.com. We welcome the opportunity to sit down with you and learn more about your situation so we can help you optimize your portfolio to meet your financial goals for years to come.

Engrave Wealth Partners Investment Committee

Bill Day, CFP®, CIMA

Taylor Parker, CFP®

Greg Parker


Footnotes:

1. Bespoke Investment Group, A Banner Year for Equities, 1/2/20
2. J.P. Morgan Asset Management, Guide to the Markets, 12/31/19
3. J.P. Morgan Asset Management, Guide to the Markets, 12/31/19
4. Bespoke Investment Group, Pros and Cons, 12/31/19
5. J.P. Morgan Asset Management, Guide to the Markets, 12/31/19
6. J.P. Morgan Asset Management, Guide to the Markets, 12/31/19
7. Bespoke Investment Group, Pros and Cons, 12/31/19
8. Bespoke Investment Group, Pros and Cons, 12/31/19

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