Investment Perspectives and OutlookF I R S T Q U A R T E R 2 0 2 0

Following 2018’s fourth-quarter market relapse, global equity returnsfor 2019 heralded a broad recovery, easily surpassing investorexpectations. Although investors have been generally skeptical sincethe beginning of the market’s decade-long recovery, this distrust wasespecially appropriate during the last quarter of 2018, on the heels ofFed rate hikes, trade war flare-ups, anemic corporate earnings andpolarizing politics.

As 2018 progressed, corporate earnings, partly fueled by theDecember 2017 tax-cut passage, were slipping into negativeterritory, and the U.S. government was also sliding into a shutdownthat would extend into January. Investors were losing confidencethat any foreseeable upside in the equity markets was possible,helping explain the exodus from the equity markets into variousperceived safe havens. The closing chapter for 2018 was one marredby four interest rate hikes during the year and the expectation of twoor three more into 2019.

Just a few months into 2019, the hangover from 2018 beganreversing course. Despite a few, sometimes significant, hurdlesduring the year, a more optimistic outlook fueled equities’ push tonew highs by the year’s close. Early in 2019, the Federal OpenMarket Committee (FOMC) set the stage for what would prove to bea banner year for the risk-on equity market environment, reversingits 2018 rhetoric and adopting a more patient monetary policyposition. To provide some perspective, by year-end 2018, the Fedhad begun to recognize that its policies were introducing unexpectedmarket risks. To remedy these risks, the Fed implemented three 0.25percent interest rate cuts through December 2019.

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An improving job environment added to what remained a strongconsumer outlook in 2019, conditions which are likely to continueinto 2020. Although the most recent December employment reportfell below expectations, the six-month average of 189,000 new jobsadded was a reminder of a still healthy market, especially given thislate in the business cycle. Today’s unemployment rate is holding at3.5 percent, with wage growth pegged near 3 percent. Further goodnews for the labor markets setting the stage for improving sentimentand consumption trends was a declining trend in lay-offs and a pick-up in the labor participation rate for those employees in the 25 to 54age group rising to 82.9 percent.

Recall in late 2018 the markets concerns over the slowdown inhousing growth, partly in tandem with rising interest rates andescalating home prices. These concerns were quickly erased this pastyear following the Fed’s easing of interest rates, helping spark buyerinterest and improving mortgage affordability. By year-end 2019,new home construction had risen to its highest level in 13 years,housing starts for December were up 16.9 percent (versus 2.6percent in the prior month) while single-family starts set a new cyclehigh. Add an increase in household refinancing applications of 73.5percent over the last year, and consumers are buying back into theirexisting homes while freeing up incremental cash-flow. Stabilizingjob growth, a still strong consumer outlook and low rates will likelycontinue the trends into 2020.

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E C O N O M I C C O M M E N TA R Y

There is a degree of optimism for 2020 based on the continuedstrength of the consumer helping boost the manufacturing sector,especially following what may be a lull in trade-wars. The outlookfor household income and job growth is positive and, while consumercredit demand is on the rise, household savings rates are still solid at8.1 percent of disposable income. In terms of current debt service,BCA Research has noted that the house debt-to-assets ratio is at itslowest level since 1985, with debt-servicing costs (9.7 percent) at itslowest share in nearly 40 years.

What is still missing today is an upturn in retail sales matching whathas been a consistently improving consumer outlook. December wasa strong month for core retail sales but the final tally for the USmarket was an increase of 0.3 percent month-over-month inDecember of 2019. Sales jumped for food and drinks, clothes, andelectronics and appliances and gasoline. Core retail sales whichexclude autos, gasoline, building materials and food services jumped0.5 percent after falling 0.1 percent in November. Year-over-year,retail sales grew by 5.8 percent, higher than November’s 3.3 percent,representing the biggest annual increase since August of 2018. Forthe full year 2019, retail sales grew by approximately 3.6 percent.

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As mentioned earlier, sentiment drivers may add support to themanufacturing sector in 2020, post trade negotiations. From theconsumer perspective, the University of Michigan Index of ConsumerSentiment remains elevated at 99.1, with current conditions outlooksitting at its best level since December of last year, and the outlookfor home purchases matching its best level back in April last year.The results were similar for small business sentiment with plans toboost capital expenditures, employment, wages (highest indicationsince 1989) and for expectation in improving sales. This sentimentwas mirrored in the most recent New York Empire ManufacturingIndex report, noting headline increases in new orders and declines ininventories (a positive for future manufacturing)

Earlier in 2019 there were growing recession fears, partly fueled bywaning manufacturing data, trade embargoes and a sometimespredictive inverted yield curve. The inverted yield curve washeadline news for several months as global investors, and centralbanks looking for yield, bid up longer-term maturities, which in turndrove yields below shorter term debt offerings. Ultimately, yieldspreads widened and investors worried less about market riskpredictors. There are also positive data points from the constructionindustry, architectural billings (future construction), capex plans andtrade treaties that should provide a modest level of GDP growth.Absent an unwarranted monetary tightening, debt build-up orinvestment imbalances, near-term recession worries should diminish.

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Trade Prospects Improving and Growth Worries Receding

By the close of 2019, a number of global market and economic issueswere being resolved. First and foremost was the off-and-on-againtrade deal with China. The now signed agreement with Chinaimplementing a “phase 1” trade deal should help mitigate simmeringtrade tensions in Asia, and reduce cross-tariff threats and investorconcerns. From an investor perspective, this agreement shouldfollow in the footsteps of the recently approved treaty between theU.S., Canada and Mexico, hopefully mitigating some uncertainty forthe manufacturing sector in 2020.

Other positive overseas actions included an early-stage resolution forBrexit; the country’s mid-December elections reaffirmed that theBritish were indeed exiting the European Union. While the finaleconomic outcome is still an unknown, the exit decision has removedone of the unresolved issues impacting markets globally over the pastthree-and-a-half years.

Across most major economies, inflation will likely stay low through2020 as will monetary policy continue to stay supportive. While wedo not expect a market follow-thru repeat of the near-record returnsin global equities, we do expect positive returns. Our forecastsinclude a pick-up in global growth, recessions avoided and aweakening in the U.S. dollar.

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Market Momentum and Investor Flows

Following the return of easy monetary policies across the globe intandem with reinvigorated consumer-driven optimism of 2019, themarkets responded accordingly. The S&P 500 posted its bestperformance since 2013, despite relatively flat corporate earningsgrowth. U.S. stocks generally outperformed their overseas peerswhile large company stocks again outperformed smaller companystocks, driven primarily by continued investor demand fortechnology-centric companies. Growth stocks also outperformedvalue stocks because of the technology bias of the growth arena.

Augmenting the equity markets environment was the reversal of afew of the 2018 macro headwinds, which helped push the S&P toclose on a decade-high note, with a +/-29 percent price return and+/-31 percent total return. All 11 sectors of the index posted positivereturns last year for the first time since 2010, as the Tech sector, notsurprisingly, was the clear winner for the year and decade, drivingnearly one-third of the S&P 500 total return for the year (and over 50percent for the decade).

Another positive for 2019 were the overseas markets. In years past,investors have avoided (or underweighted) the Developed andEmerging equity markets. With valuations in the domestic marketsre-inflating from last year, investors began nibbling on the less-expensive foreign equities which also benefitted from the underlyingaccommodative global monetary policies.

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Market Momentum and Investor Flows

So what is our equity outlook for 2020? A few of our earlier trade-focused worries have lessened, although a few distinct concernscontinue overseas (Russia, Iran and North Korea) and at home(upcoming elections). It’s also highly unlikely that we revisit thefantastic equity returns of 2019 absent further monetary easing. Andwhile today’s equity markets are essentially pricing in a continuationof positive economic and earnings news (somewhat expensive), theyare still attractive from a valuation perspective relative to the fixed-income markets.

Other factors underlying our market outlook through 2020 include aslow reversal in earnings trends, the current state of the economycontinuing, as well as the underlying support for last year’s marketmomentum. 2019 was a market environment where despitecorporate earnings remaining relatively flat to slightly negative,investors continued to bid the markets high. This was counter to2018 when earnings growth was north of 20 percent and yet themarkets turned negative during the final quarter.

In 2020, we are expecting a slow improvement from the earningstrough of 2019 (mid to high single digit growth) but with (S&P 500)equity multiples currently stretched. What we shouldn’t be overlyconcerned about for 2020 though are a sudden slate of rate hikes, aspike in oil prices, but we do count on a pick-up in global trade,manufacturing output and a still healthy consumer and job market.

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Monetary Policy is Still a Key Factor

Last year was an exceptional year for US bonds and it all began with theUS Treasury market. Despite a trillion dollar a year federal budgetdeficit and an ever-growing supply of US Treasury securities, the marketrallied and yields materially declined throughout the year. Supported byeconomic growth concerns here at home and around the globe, theFederal Reserve lowered the Fed Funds target rate three times over theyear, a move which was mirrored by many of our overseas central bankpeers.

Money market rates were volatile as last year began, on the heels of theFOMC having lifted the federal funds rate target on two occasions in2018. This resulted in money market rates having reached their highestlevel in over a decade, only to reverse course in 2019 given a weakeningglobal economy and significant concerns over global trade. Additionally,during the 4th quarter the all-important REPO (“repurchase agreement”)market came under a significant amount of stress for a myriad ofreasons, leading to the Federal Reserve stepping in and providingtemporary liquidity to this institutional investor dominated portion ofthe larger money market space. At the other end of the spectrum, highyield returns tracked positive through most of the year but at quarter’send this segment of the market proved to be the best performing sectorfor that three-month time frame.

Whether we see rising yields in intermediate and long-term bondsdepends on rising inflation expectations. With the economy showingresilience and core inflation edging up, inflation expectations shouldmove higher. The lagged impact of the Federal Reserve’s interest ratecuts, signs of stabilization in the global economy, and a modest uptick ininflation expectations could provide a boost to intermediate and long-term bond yields. One potential downside to our outlook is the ongoingthreat of trade tariffs weighing on business investment.

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This commentary is furnished for informational purposes only and is not investment advice, a solicitation, an offerto buy or sell, or a recommendation of any security to any person. Managers’ opinions, beliefs and/or thoughtsare as of the date given and are subject to change without notice. The information presented in this commentarywas obtained from sources and data considered to be reliable, but its accuracy and completeness is notguaranteed. It should not be used as a primary basis for making investment decisions. Consider your ownfinancial circumstances and goals carefully before investing. Certain sections of this commentary contain forward-looking statements that are based on our reasonable expectations, estimates, projections, and assumptions.Forward-looking statements are not indicators or guarantees of future performance and involve certain risks anduncertainties, which are difficult to predict. Past performance is not indicative of future results. Diversificationstrategies do not ensure a profit and cannot protect against losses in a declining market. All indices areunmanaged and investors cannot invest directly into an index. You should not assume that an investment in thesecurities or investment strategies identified was or will be profitable.

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