From my post a year ago:
“As widely expected … the Federal Open Market Committee (FOMC) voted unanimously to increase its federal funds rate target by 25 bps, bringing it to 2.25%–2.50%. … the year-end read of fed funds futures prices indicated a nearly 90% probability of no Fed hikes in 2019. … the FOMC also reduced its projections for 2019 rate hikes from three to two.”
Those projections proved to be dramatically inaccurate. Indeed, the FOMC cut rates three times in 2019, bringing the target rate to 1.50%–1.75%. At year-end 2019, fed funds futures prices indicated a less than 50% probability of any Fed action in 2020, and the most recent “dot plot,” which illustrates projections of FOMC members, implied no rate cuts in 2020 and only one in 2021.
Fed cuts fueled risk appetite and all major asset classes posted above-average returns—many of them in double-digit territory. While negative returns in 2018 are part of this picture, this degree of broad-based outperformance is unusual, if not unprecedented. The Fed’s “pivot” was the most obvious contributor to stellar performance given that the economic picture was largely unchanged. Unemployment lingered at historically low levels, GDP growth hovered around 2%, consumers continued to spend, and inflation remained benign. The manufacturing sector continued to be a relatively lone point of weakness.
The U.S. economy closed the year with the unemployment rate at a 50-year low of 3.5%. The final reading for third quarter GDP showed a 2.1% gain, with personal consumption expenditures up 3.1%. November’s headline CPI print was 2.1% (year-over-year) while the core measure was 2.3%. The Fed’s preferred inflation gauge, the Core PCE Deflator, rose 1.7% over the trailing year. Manufacturing remained weak. The December Manufacturing ISM (released on Jan. 2) was 47.2, below 50 for the fifth consecutive month. Readings below 50 signal contraction.
Equity markets were propelled to record highs and even fixed income investors were rewarded with nearly double-digit returns, an amazing feat given the sector’s paltry yields. December capped a 129-month bull market for the S&P 500 Index, the longest ever and a cumulative return of nearly 500% since March 9, 2009. Going into year-end, perceived progress in U.S./China trade negotiations, some degree of closure around Brexit, and expectations for the Fed to remain on hold for the foreseeable future overshadowed various areas of concern including unrest in Hong Kong, tensions in the Middle East and North Korea, the ongoing impeachment proceedings in the U.S., and ballooning federal debt. Further, Boeing’s temporary cessation of 737 Max production is expected to trim 0.5% off first quarter GDP growth.
Outside of the U.S., rate cuts were prevalent across developed markets in 2019 but economic news was largely unchanged throughout the year. GDP growth across developed markets remained weak but largely positive. The most recent annual growth rate for the euro area was 1.2% and for Japan, 1.7%. As in the U.S., manufacturing continued to be a weak spot given a fall-off in global demand as well as the imposition of trade tariffs. The global manufacturing PMI was 50.3 in November, but that was due partly to modest expansions in emerging market countries Brazil, China, and India. Global inflation also remained benign at 2.0% in October, with the figure for developed markets being a more meager 1.5%, according to data from JP Morgan.
While 2018 was an unusual year where virtually all asset classes posted negative returns, 2019 was equally rare with all major asset classes delivering above-average returns. Our head of capital markets, Jay Kloepfer, fondly labels 2019 a “two standard deviation event” and certainly a year that few expected in spite of the disappointing results in 2018. The year serves as a good reminder of the importance of adhering to a disciplined process that includes a well-defined long-term asset allocation policy.
