Commentaries
PMC Weekly Review - December 16, 2019
As long as the music is playing, you’ve got to get up and dance
Although for many of us-including the writer of this piece-December arrived way too early this year, a lot has happened in the markets and economy since the end of last year. December 2018 rocked capital markets with domestic and international equities plummeting by double digits, heightened volatility, and a US government shutdown that turned out to be the longest in history. Global growth concerns, trade disputes and the US yield curve inversion continued to rattle investors’ nerves in 2019, and as the year concludes, it may make sense to compare the state of the affairs – where we are year to date versus where we were 11 months ago.
Let’s start with the Federal Reserve (the Fed), as its interest rate policy has been one of the most important factors moving the markets in the last couple of years. After raising rates four times last year, the Fed backtracked, cutting them three times in 2019 and reversing nearly all of 2018’s rate increases as uncertainty from trade wars and slowing global growth continued to pose risks to the United States economy. The current benchmark interest rate range of 1.5%-1.75% is much lower than the 2.25%-2.50% range at the end of 2018. In addition, unlike the prior year, market participants expect rates to remain low for the foreseeable future. Other central banks continue to mirror the Fed’s dovish stance by keeping in place accommodative policies in efforts to stimulate substantial economic growth.
Nevertheless, growth slowed in the US in 2019, with real GDP up by an annualized 2.3% in the first three quarters of the year versus an average of 3.1% increase recorded in 2018. Similarly, the global economy has slowed down and global trade remains under pressure as 2019 concludes, while geopolitical and political tensions around the world continue to add uncertainties. Despite all this, capital markets seem to have shrugged off the wall of worry and have marched higher since the end of last year.
Unlike 2018, which saw an increase in yields, so far this year yields have declined across the board, with the US 10-year Treasury yield closing out November at 1.78%, down from the 2.68% level at the end of 2018. Sovereign bonds in other parts of the world followed similar patterns, with the Japanese and German yields currently in negative territory. Spreads have also tightened across the board, with investment grade corporate bond spreads currently at 105 bps, versus 153 bps at the end of 2018 and high yield spreads at 401 bps against the 533 bps level at the end of last year. After finishing 2018 pretty much flat, the Barclays Aggregate index is up 8.79% year to date. The lion’s share of this return was contributed by the investment grade sector, which is up 14.17% as of the end of November, in stark contrast with the -2.51% return posted in 2018. Lower quality bonds also experienced sustained strength in the year, with the high yield asset class returning over 12% year to date, compared with a loss of 2.26% in 2018.
Lower yields were not a characteristic of fixed income markets alone, as equities, both domestic and international, also experienced shrinking yields. Equity valuations, as measured by price-to-earnings ratios, have levitated year to date, with large cap growth and small cap equities concluding November at valuations close to their 10-year highs. In a stark contrast with 2018, the S&P 500 Index is up 27.63% year to date. Similar to last year, the Russell 1000 Growth Index is leading the way within US equities, with a return of 32.40% as of November 30, while large cap value stocks are up 23.15%. International and emerging markets equities have gained 18.17% and 10.20% so far this year, compared with the negative double digit returns posted in 2018. Commodities and liquid alternative strategies have also posted positive absolute results year to date.
It is somewhat surprising to see such spectacular results from capital markets in times of heightened economic, trade, and geopolitical risks. Although anything can happen from now until the end of the year, as December 2018 demonstrated, it looks like so far, a dovish Fed, a relatively strong consumer, and an unwavering job market have been all what was needed to keep the music going. As 2019 comes to an end and year-end holidays approach, let’s hope and cheer for more of the same.
“When the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you’ve got to get up and dance.”1
Sonila Gjata
Portfolio Manager
1Citi’s Chuck Prince FT Interview, July 2007 https://www.ft.com/content/80e2987a-2e50-11dc-821c-0000779fd2ac
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