Market Insights & Commentary – December 2019

2019 was an anomaly because almost all asset classes delivered returns above their 10-year averages. Historically, stocks perform better when the economy is expanding and bonds perform better when the economy is contracting. Despite the lack of drama in the U.S. equity markets, behind the scenes many factors shifted the trajectory of the global economy.

Global Economy:

The Trade War, Brexit, and global monetary policy ruled the headlines in 2019. The tensions between China and the U.S. caused a slowdown in the Chinese economy and a great deal of uncertainty in the U.S. stock market over the last 18 months. As of December 13th, President Trump has agreed to the first phase of a trade deal with China, which will roll back some existing tariffs. The deal is only the first phase, but it could help ease tensions and alleviate China’s struggling economy.
Britain has officially voted to leave the European Union. Brexit has been the center of many debates since the original referendum in 2016, but has now reached an answer. Britain must now navigate leaving the E.U., while also balancing a fragile economy.
Interest rates have dropped below zero in many European countries, as well as Japan, in efforts to encourage people to spend their hard-earned money and support their individual economies. Unfortunately, this strategy hasn’t been able to push the economies out of the later stage of the cycle and the E.U. continues to slow.

The U.S. Economy:

You wouldn’t know it by looking at the stock market, but the U.S. economy is cooling off. The economy is near the end of the business cycle, but it is still being supported by consumer spending and low unemployment rates. Corporate earnings have continued to grow, but at a slower rate. The Federal Reserve joined the international trend of lowering interest rates throughout 2019, after raising rates four times in 2018. Lowering rates boosted bond prices and created an environment where U.S. bonds and stocks were both positive for the year. The interest rate movements also created an inverted yield curve. An inverted yield curve happens when shorter term rates are higher than longer term rates. For example, the yield on a 10-year Treasury dropped below the yield of a 3-month Treasury. Monitoring the yield curve is important because it can be a sign of a weakening economy and a future recession. The yield curve has since rebounded and is no longer inverted.

What to Expect for 2020:

The markets always come with their fair share of unknowns, but investors can expect a few changes in 2020. The Federal Reserve will most likely be less active than what we have seen in the last 2 years. After 4 rate hikes in 2018 and 3 rate cuts in 2019, the Fed will probably take a back seat in 2020. The U.S. is currently in the slowdown phase of the business cycle which tends to be when we see increased volatility in the stock market. The Presidential Election of 2020 will only add to the expected volatility. On a global scale, international stocks are priced below historical averages, but will be impacted by Brexit, the Trade War and the much needed reacceleration of economic growth (or lack thereof). To conclude, 2019 was an anomaly both for stocks and bonds. Recession fears for 2020 have faded, tensions with China have eased and The Federal Reserve may have an uneventful year. Regardless of what’s happened and what’s yet to come, we believe portfolio diversification, understanding your risk tolerance, and talking to your financial advisor should be on your list of things to do in the New Year.

Value vs Growth

When it comes to investing in stocks, there are many different approaches. Two popular styles are value and growth investing. While both styles seek to take advantage of capital appreciation over time, they go about finding which stocks to buy in a very different manner.

There are many methods to determine the fair price of a particular stock. When you buy a stock, you are buying a share of the future earnings of that particular company. One metric that is often used to analyze stocks is called the Price-to-Earnings (P/E) ratio. This ratio tells us how much a shareholder is willing to pay per dollar or earnings for a company. A higher PE ratio means a more expensive stock, and a lower PE ratio signals a cheaper stock.

Growth stocks typically have higher PE ratios than their peers. The reason is they have exhibited higher-than-average earnings growth, and are expected to continue on this high growth trend. Growth investors believe these stocks have higher earnings potential, and are willing to pay more for them. Growth stocks are more volatile than the broader market, meaning they are more sensitive to market shocks.

Value stocks typically have lower PE ratios than their peers. Value investors seek stocks that have experienced poor price performance, but still have strong fundamentals. The goal of value investing is to buy stocks cheaper than the broader market, and experience capital appreciation once the market realizes the fair value of the stock is higher than when it was originally purchased. Value stocks are typically less volatile than the broad market.

Which is Better?

Whether you are a value investor or growth investor, you can always find a timeframe where your particular strategy is advantageous. Since the Great Financial Crisis in 2008 and 2009, however, growth has been king. In the 10 years prior to September 2019, the Russell 1000 Growth index gained 14.72% per year, compared to 11.26% per year for the Russell 1000 Value index. The reason for the outperformance of growth has to do with being in the longest economic expansion in U.S. history, as well as one of the longest bull markets. Value investing tends to outperform when the economy starts to contract and enter into a recession.

At Sharkey, Howes & Javer we implement both styles of stock investing. If you want to learn more about these types of equity investing, please get in touch with us today for a complimentary consultation with a CERTIFIED FINANCIAL PLANNER™.