Thank you for your continued relationship with Roehl & Yi Investment Advisors and for allowing us to help you share in the year of great market performance that was 2019. You have profited from one of the best equities and fixed income markets in many years; however, it wasn’t always smooth sailing. Last year will be remembered as a year of trade wars, impeachment proceedings, and dovish Federal Reserve policy. Those who didn’t lose their cool in the last months of 2018—when downside volatility of 20% created havoc in the markets—were rewarded for their patience in 2019.
This year got off to a good start with headlines of a likely settlement to the US-China trade war. That positive news abruptly turned negative with bomb strikes in the Middle East and increased tensions between the US and Iran. Such geopolitical tensions are inevitable over time and it can be difficult to assess how the conflicts will affect the global economy. As we have cautioned before, in times when politics and global conflict create headlines and perceived or actual crises, it is important to focus on the economic fundamentals and tune out the noise.
We have recently received calls from concerned clients asking about how increased political tensions might affect markets and, more specifically, portfolios. It is impossible to predict the future but looking at similar past events may allow some perspective. In the following table, we are showing stock returns in the year that a significant event occurred. Some declines are relatively modest, and some gains substantial. The bottom line is geopolitical turmoil and wars don’t automatically lead to weak markets.
| Year | Event | S&P 500 Return: |
| 1950 | Korean War | +30.81% |
| 1953 | Russia Explodes H-Bomb | -1.21% |
| 1961 | Building of Berlin Wall | +26.64% |
| 1966 | Escalations of Vietnam War | -9.97% |
| 1990 | Iraq invades Kuwait | -3.06% |
| 2001 | September 11 | -11.85% |
| 2003 | U.S. Invasion of Iraq | +28.36% |
Source: Morningstar
After falling 20% in the final quarter of 2018 as mentioned above, the US stock market surprised us with a rise of 34% in 2019. As shown in Table 2 below, the rally broadened to include major asset classes around the world. This followed 2018 when everything except cash fell in value.
Aggregate corporate profits were modest in 2019 so the significant market rise can likely be attributed to the increase in investor optimism and falling interest rates. The equity markets took off when the Federal Reserve had a change of heart and began signaling it would cut rates in early 2019. The Fed cut three times to move short-term borrowing rates back down to approximately 1.5%. This rate is below the general inflation rate of a bit over 2%. It seems clear the Federal Reserve is determined to support financial markets with monetary policy that is highly stimulative and borrower friendly. Looking forward, it may be a challenge for further profit growth to catch up to today’s stock prices.
Table 2 Source Morningstar
The combination of the Fed’s monetary policy noted above, aggressive fiscal policy (tax cuts), and increased federal spending is not sustainable but acts as short-term stimulus for the economy and markets. We now have had three years of the Consumer Price Index above 2%. Though inflation is still modest and at an acceptable level for the Fed, it may become a risk for the future. A lot depends on voters and then our government’s responses to structural issues around debt and taxation.
Finally, from Sellwood Consulting, here is a look at how cheaply or expensively the major asset classes around the world are priced relative to their own history. This graph shows the historical range for a typical measure of “value” for each market, along with today’s corresponding price. Save for foreign stocks, we can see just about everything is pegged into the top quartile of its history, indicating just how tough it is to find bargains in the world these days. Look for the tip of the arrow to see the location and direction of the given market’s current relative “value.”
Because of the rise in markets in 2019, it is now difficult to find reasonably priced investment options. Expect more modest returns in 2020 as general investor enthusiasm and Federal Reserve policy has pushed markets to elevated levels—especially here in the US. The good thing is that the US economy is very healthy. Employment and consumer confidence are at historic highs. With earnings season just starting, better-than-expected results and decreased political tensions ought to calm the nervous.
We hope this letter has been of some assurance to you; as always, we are here to answer any questions you may have. We hope you and your loved ones have a happy and healthy 2020.