Winter 2019 Quarterly Newsletter

Jan. 17, 2020 | in Newsletter

Market & Economic Update

By Nicholas A. Boyer, Chief Investment Officer/Executive Vice President

As we close out a year dominated by dramatic headlines and consternation regarding the state of the economy and financial markets, pundits and investors alike have begun to catch up to our long-held view that the economy remains on sound footing and financial markets remain strong.

“Animal Spirits” Thriving

In fact, the S&P 500 Index delivered total return of 9.1% for the fourth quarter of 2019 and an incredible 31.5% for the full year.[1] Globally, the MSCI All Country World Index (ACWI) returned 9.1% for the fourth quarter of 2019 and 27.3% for the year. For the full year 2019, the International Developed benchmark MSCI EAFE Index produced 22.8% while the MSCI Emerging Market Index generated 18.6% in total return.

Overall, the market benefitted from easier monetary policy, incremental progress in U.S.-China trade relations and generally positive economic data. Although corporate earnings growth moderated, particularly compared to stock price gains, consensus estimates point to corporate earnings reaccelerating in 2020. Importantly, while equity valuations are full, the market has not yet reached euphoric levels,[2] and key measures of sentiment including consumer confidence and business confidence surveys have turned up and remain quite strong heading into the new year. [3][4]

Iran, Oil and Geopolitical Risks

As we look ahead, we must caution that investors can never fully discount the risks associated with a global military conflict – the kind of event that is impossible to predict. This remains particularly true amidst a shifting geopolitical landscape in the wake of perhaps the most significant changes to U.S. foreign policy in the Middle and Far East in a generation.

Yet while global shocks are always possible, the imminent threat of risks from geopolitical and trade conflicts appear to have abated with U.S.-Iran tensions having de-escalated, while Chinese officials have confirmed a “phase one” trade deal will be signed.

We generally agree with most analysts who believe that full-scale war between the U.S. and Iran remains unlikely.[5][6] But ongoing tension may create bouts of volatility in financial markets, particularly in crude oil given Iran’s membership in OPEC and role in the global oil trade.[7] However, as we’ve noted in the past, history suggests the impact on equity markets from geopolitical events is often largely transitory.[8] Moreover, as Federal Reserve research has acknowledged, the risks that rising oil prices pose to the global economy have substantially diminished over the last few decades.[9][10] This is in part because of what Nancy Lazar of Cornerstone Macro refers to as the “U.S. Energy Renaissance”:

“From 1970-2007, there was a clear negative correlation between swings in oil prices and GDP. Today it’s basically neutral. Capex’s positive correlation with energy prices will basically offset their negative relationship with consumer spending. And with the U.S. now energy independent, the impact on trade is basically nil … The U.S. Energy Renaissance drove domestic oil production to new heights, as the country imported less oil from OPEC. The EIA projects the U.S. will be energy independent this year. Indeed, the Energy Renaissance is a secular game changer – domestically and globally. Starting in September 2019, the U.S. posted its first trade surplus in crude oil and petroleum products in many, many decades. The facts have changed.”[11]

Governments Still Awash In Debt

Given the prospect of geopolitical tail risks having meaningfully diminished, several key economic indicators point to a healthy economy in the new year, and the U.S. consumer remains very well positioned to drive economic growth through 2020.[12][13]

Yet perhaps the most significant long-term risk to the global economy and financial markets remains the severe imbalances that have appeared in government finances since the financial crisis.

While the monetary policies of the last decade have generally been credited with helping to avoid a repeat of the Great Depression, they have also resulted in significant unintended consequences. These policies have incentivized investment in equities and fixed income instruments over traditional savings accounts, resulting in financial asset price inflation.[14]

But as we’ve touched on before in our Fall 2019 quarterly update, perhaps the more glaring and troublesome effect of this unprecedented expansion of money and credit has been the ability of governments to finance severe fiscal excess. The new update of the International Monetary Fund’s Global Debt Database shows the global average debt-to-GDP ratio (weighted by each country’s Gross Domestic Product) edged up to 226% in 2018 – a 1.5% increase from 2017.[15]

But The Fed Can Monetize Debt Longer Than You Can Remain Solvent

Still, whether or not investors agree with the path of fiscal and monetary policy, the Federal Reserve has been in the driver’s seat for financial markets since the crisis. More recently, from late 2016 through 2018, amidst a surging equity bull market, the Federal Open Market Committee (FOMC) increased interest rates seven times in three years, tightening monetary policy and pushing equities to the brink of a bear market, as the S&P 500 declined nearly 20% into the end of 2018. While this might have pushed the U.S. into a recession, the subsequent turnaround in market performance in 2019 was driven in large part by the Fed’s rapid easing of monetary policy. The FOMC lowered interest rates three times reversing nearly all of the 2018 hikes, and also began its balance sheet expansion anew with repo-market liquidity injections in September of last year (see chart below).[16]

The consensus view is that absent any major shocks, the FOMC will remain on hold in 2020. Yet in keeping with current monetary policy objectives, the Fed will likely continue to grow its balance sheet as much as necessary in order to supply liquidity to the market, and is prepared to cut rates again if the economic outlook deteriorates.[17] Accordingly, we remind investors to heed the old adage “don’t fight the Fed,” and we expect ample liquidity and credit available to businesses and consumers to remain a strong support for financial markets and the economy in 2020.[18][19]

Ultimately, we still expect market volatility to increase, particularly as we head into the U.S. presidential election, and think it’s unlikely that returns will match the pace of 2019. However, we believe the positive drivers of equity markets – easy monetary policy, favorable financial conditions and a strong consumer – are likely to continue to sustain positive total returns. As usual, we want to remind investors to remain disciplined in their long-term strategy and avoid trying to aggressively trade these markets. As always, please feel free to reach out with any questions or to discuss your investment strategy in further detail.

[1] Bloomberg Market Monitor. January 3, 2020
[2] Roberts, Lance. “The Stock Market Has Become A Private Club for the Elite,” Advisor Perspectives, December 23, 2019. (https://www.advisorperspectives.com/commentaries/2019/12/23/the-stock-market-has-become-a-private-club-for-the-elite.pdf)
[3] Cornerstone Macro. “Watching Closely Consumer and Business Confidence.” Page 2. CSM Eco Outlook: U.S., January 8, 2020.
[4] National Federation of Independent Business (NFIB) Small Business Optimism Index. November 2019 Report. (https://www.nfib.com/surveys/small-business-economic-trends/)
[5] Shepherdson, Ian. The Weekly U.S. Economic Monitor. Pantheon Macroeconomics. January 6, 2020
[6] Cornerstone Macro. “Iran In Perspective.” CSM U.S. Policy, January 10, 2020.
[7] International Monetary Fund. “Middle East and North Africa Regional Economic Outlook.” Middle East and Central Asia Department.
October 28, 2019. (https://www.imf.org/~/media/Files/Publications/REO/MCD-CCA/2019/October/English/MENAP-Presentation-1019.ashx)
[8] LPL Financial Research. “How Stocks Do During Geopolitical Events” Market Blog. January 8, 2020. (https://lplresearch.com/2020/01/08/how-stocks-do-during-geopolitical-events/)
[9] Federal Reserve Bank of San Francisco. “What are the possible causes and consequences of higher oil prices on the overall economy.”
Education: Publications. November 2007. (https://www.frbsf.org/education/publications/doctor-econ/2007/november/oil-prices-impacteconomy/)
[10] Mankiw, Greg. “Where have all the oil shocks gone?” Greg Mankiw’s Blog: Random Observations for Students of Economics. October
28, 2007. (http://gregmankiw.blogspot.com/2007/10/where-have-all-oil-shocks-gone.html)
[11] Cornerstone Macro. “The Big Risk: U.S./Iran Tensions. The Big Game Changer: U.S. Energy Renaissance.” CSM Eco Outlook: U.S.
January 8, 2020.
[12] The Employment Situation – December 2019, U.S. Department of Labor, Bureau of Labor Statistics, January 10, 2020.
(https://www.bls.gov/news.release/pdf/empsit.pdf)
[13] Institute for Supply Management (ISM). December 2019 Non-Manufacturing ISM. “Report on Business.” January 7, 2020.
(https://www.instituteforsupplymanagement.org/ISMReport/NonMfgROB.cfm)
[14] Jorda, Oscar, Moritz Schularick, Alan M. Taylor, Felix Ward. 2018. “Global Financial Cycles and Risk Premiums” Federal Reserve Bank
of San Francisco Working Paper 2018-05. (https://ideas.repec.org/p/fip/fedfwp/2018-05.html)
[15] International Monetary Fund. “General government gross debt, percentage of GDP,” IMF DataMapper. World Economic Outlook.
October 2019. (https://www.imf.org/external/datamapper/datasets/WEO)
[16] Bloomberg FARBAST Index. January 13, 2020.
[17] Cornerstone Macro. “Quick Take: Is It Time To Stop Obsessing About The Repo Market?” CSM Global Policy. January 8, 2020.
[18] Bank of International Settlements. “Global Liquidity Indicators.” www.bis.org. December 8, 2019
[19] International Monetary Fund. “Currency Composition of Official Foreign Exchange Reserves (COFER)”
(http://data.imf.org/?sk=E6A5F467-C14B-4AA8-9F6D-5A09EC4E62A4). December 30, 2019.

Team Update: Tyler Harris joins RKL Wealth Management

We are pleased to announce that Tyler Harris has joined our firm as a Senior Wealth Analyst. In his new role, he will work closely with investment managers and wealth planners to provide a collaborative client experience. He will also help build and monitor the firm’s investment models to ensure our clients are in the best position to achieve long-term investment success.

A Certified Financial Planner (CFP®), Tyler brings more than seven years of experience in financial planning, portfolio analysis and relationship management to RKL Wealth Management. He earned a B.A. in Finance and Economics from West Chester University of Pennsylvania and resides in Lancaster.

IMPORTANT CONSIDERATIONS
The views and opinions expressed are for informational and educational purposes only as of the date of writing and may change at any time based on market or other conditions and may not come to pass. This material is not intended to be relied upon as investment advice or recommendations, does not constitute a solicitation to buy or sell securities and should not be considered specific legal, investment or tax advice. The information provided does not take into account the specific objectives, financial situation, or particular needs of any specific person. All investments carry a certain degree of risk and there is no assurance that an investment will provide positive performance over any period of time. The information and data contained herein was obtained from sources we believe to be reliable but it has not been independently verified. Past performance is no guarantee of future results.

RKL Wealth Management LLC is a registered investment adviser. To learn more about how we can help you meet your goals, please contact our office at (717) 399-1700 or via our website, rklwealth.com. Additional information is available upon request.

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