Weekly Market Update (January 13 – January 17, 2020)

By Angelo Kourkafas January 17, 2020

The combination of better-than-expected economic data, encouraging corporate earnings from U.S. banks, and the signing of the "phase-one" trade agreement pushed U.S. stocks to fresh record highs last week. Strong retail sales and a surge in housing starts point to a resilient consumer supported by the health of the labor market. The long-awaited "phase-one" trade agreement between the U.S. and China was formally signed last week, largely meeting expectations. Specific terms included commitments from China to increase purchases by $200 billion over the next two years ($78 billion of manufactured goods, $52 billion in energy, $32 billion of agricultural products, and $38 billion in services). We believe that the agreement removes some uncertainty, but trade issues will likely remain a source of volatility in the year ahead.

A Trade Deal and Our Quarterly Market Outlook

Stocks closed at record highs last week as the U.S. and China signed the long-awaited "phase-one" trade agreement. The terms of the deal were largely in line with expectations and included commitments from China to increase its purchases of U.S. goods and services by $200 billion over the next two years.

In our view, the recent trade agreement is a major step towards de-escalation of the trade tensions between the two countries. It removes the near-term threat of new tariffs and raises the hopes for a more comprehensive deal to be achieved. However, tariffs on two-thirds of U.S. imports from China remain in place, and attention now shifts to implementation and enforcement. Potential failure to meet the terms of the deal can create temporary setbacks and result in additional retaliatory tariffs. We believe further tariff relief, or a more comprehensive truce including structural issues, like industrial subsidies, is unlikely to materialize before the U.S. election. Last week's agreement removes some uncertainty, but trade issues will likely remain a source of volatility in the year ahead. More broadly, we expect stocks to continue to rise but at a slower pace than they have over the past decade, supported by ongoing economic growth, modest earnings growth, and accommodative central banks. Here is an overview of our latest quarterly market outlook: 

Economic Outlook: Consumers Lead the Way
We expect growth to slow in 2020 to just below the 10-year expansion average, with no catalysts such as tax cuts expected to reinvigorate growth. We expect consumers to fuel the economic expansion. In addition, interest rate cuts enacted last year should provide a modest support to the economy in the first half of 2020.

  • A healthy labor market and low interest rates will help drive spending again this year, though with less potency than last year. Monthly job gains are leveling off, but we still expect the unemployment rate to stay under 4% this year.
  • Manufacturing should show a slow but steady expansion. Importantly, the lull in manufacturing growth has not spilled over to the much larger service sector. The signing of the "phase-one" trade deal removes some uncertainty, but questions remain.
  • We expect the Federal Reserve to maintain the current target in interest rates and the rate cuts enacted last year to help ease the friction from geopolitical headwinds and election uncertainty.

Equity Outlook: More Moderate Gains Ahead
2019's gains were among the strongest of the 2000s and well outpaced our expectations. We don’t think this exhausts the bull market’s tank, but it does temper our expected return for this year.

  • We think an uptick in volatility, and a short-term pullback, is a reasonable expectation. However, we don’t think pullbacks will give way to a bear market, as the conditions that are historically associated with a bear market are not in place. In the 16 years since 1950 in which unemployment was below 4.5% heading into year-end (currently 3.5%), the average S&P 500 return in the following year was 9.9%1.
  • In our view, 2019's sizable returns won't be replicated this year. However, since 1950, when the S&P 500 rose by more than 20%, the average return in the next year was 11.3%, indicating that great years don’t have to be followed by bad ones1.
  • With valuations slightly above long-term averages, there is limited potential, in our view, for material expansion in the price-to-earnings ratio from here, meaning that the pace of market gains will be set by the pace of earnings growth.

Fixed Income Outlook: Long-term Rates Likely to Rise Modestly
We expect equities to outperform bonds this year as moderate economic growth continues, with no recession imminent. However, political and other uncertainties could drive volatility higher, highlighting the stabilizing role fixed-income investments typically play during market pullbacks.

  • Last years sizable decline in long-term interest rates reflected recession fears, a global slowdown, and expectations of a Federal Reserve policy shift. With global growth showing signs of stabilization, trade tensions easing, and market expectations more aligned with current monetary policy, we don’t think the 10-year Treasury yield is likely to fall materially below 2%.
  • We believe the bar for the Fed to either lower or raise interest rates is set very high leading up to the 2020 election. Improving economic data and less risk of a further slowdown in global growth should mean no further rate cuts are needed. At the same time, inflation is running stubbornly below the Fed’s target, providing flexibility to remain accommodative without having to raise rates.
  • Monetary policy changes impact the real economy with a lag of typically six to nine months. Therefore, we expect the markets and the economy to continue to benefit from last year’s interest rate cuts.

International Outlook: Global Growth on Track to Rebound
International stocks performed well in 2019 but still trailed the U.S. amid trade and other geopolitical uncertainties. Challenges remain, but there are signs global manufacturing may be stabilizing. We expect a modest re-acceleration in global growth. Together with depressed valuations and a likely softening U.S. dollar, this could position international investments to outperform in 2020.

  • Forward-looking business surveys have shown signs of economic activity bottoming in emerging and developed markets and are consistent with an improving demand environment. At the same time, activity in the services sector of most major economies remains robust, and central-bank policies are likely to stay accommodative until growth or inflation picks up.
  • International stocks are priced at a 20% discount to U.S. stocks, with emerging-market stocks at a 30% discount2. While valuations alone don't necessarily translate to better short-term results, they have historically been a good predictor of long-term returns.
  • In six out of the past seven years, the rising dollar reduced returns for international developed stocks by an average of 3%2. We expect the dollar to flatten or fall as global growth stabilizes and potentially rebounds.

Angelo Kourkafas, CFA
Craig Fehr, CFA
Nela Richardson, PhD
Sloane Marshall

Source: 1. FactSet 2. Bloomberg

Index Close Week YTD
Dow Jones Industrial Average 29,348 1.8% 2.8%
S&P 500 Index 3,330 2.0% 3.1%
NASDAQ 9,389

2.3%

4.6%

MSCI EAFE 2,058 0.8% 1.0%
10-yr Treasury Yield 1.83% 0.0% -0.1%
Oil ($/bbl) $58.70 -0.6% -3.9%

Bonds

$113.07 0.1% 0.7%
Source: Morningstar, 01/17/2020. Bonds represented by the iShares Core U.S. Aggregate Bond ETF. Past performance does not guarantee future results.

The Week Ahead

U.S. markets are closed on Monday in observance of the Martin Luther King Jr. holiday. Important economic data being released include pending home sales on Wednesday, the leading index on Thursday, and the Markit Purchasing Managers' Index on Friday. On the corporate front, the earnings season will begin to heat up, with 43 companies of the S&P 500 reporting fourth-quarter earnings.

Important Information

The Weekly Market Update is published every Friday, after market close.

Market indexes are unmanaged and cannot be invested into directly and are not meant to depict an actual investment.

Past performance does not guarantee future results.

Diversification does not guarantee a profit or protect against loss.

Dividends may be increased, decreased or eliminated at any time without notice.

Investors should understand the risks involved of owning investments, including interest rate risk, credit risk and market risk. The value of investments fluctuates and investors can lose some or all of their principal.

Special risks are inherent to international investing, including those related to currency fluctuations and foreign political and economic events.

The content of this report is for informational purposes only and should not be interpreted as specific investment advice. Investors should make investment decisions based on their unique investment objectives and financial situation. While the information is believed to be accurate, it is not guaranteed and is subject to change without notice.

The Dow Jones Indexes are proprietary to and distributed by Dow Jones & Company, Inc. and have been licensed for use.

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