The Wall Street Journal reported on Thursday, January 2^nd, in a front-page article: “Stocks Around World Charge Into 2020: The Dow Jones Industrial Average’s more than 170% rise from 2010 to 2020 ranks as just the fourth-best decade-long performance in the past 100 years”. What is not mentioned is that, at the beginning of 2010, we were still reeling from the devastation to the market that took place from 2007 to 2009. On October 8, 2007, the S&P 500 Index hit a high of 1576. At the beginning of 2010, it was at 1117, or 29% below where it had been about 2 years earlier.

The stock market can be very volatile during any given period. We don’t have to look back to 2010, however, to recognize the volatility of the stock market. If we go back to 2018, the fourth quarter saw the S&P 500 Index down 14% and for the year a loss of 6.2%. It is no wonder everyone is so joyous over the S&P 500 going up 28.9% in 2019. Once again, if we look at the beginning of 2018 when the S&P 500 Index was at 2674 and the end of 2019 when the index closed

at 3231, we have a gain of 21% over a 2-year period. The stock market did

do well over this period, but as with the period 2007 to 2010, the rise in value was not smooth.

While significant gains can be earned with stocks, they also have periods where the losses can be substantial. Diversification of asset classes, such as adding bonds, real estate, commodities, etc. may help to lower this volatility. We saw major volatility from 2007 to 2009 and again in 2018. We will likely see it again in the future.

Looking Ahead

We have a bull market that continues. While the market has had corrections, we have not seen a bear market, which would be a drop of about 20%, in more than 10 years. Could this be in our near future?

Let’s first look at the negatives facing the stock market. In April an inversion of interest rates occurred, where short-term Treasury yields exceeded long-term yields. It reversed quickly when short-term treasury rates exceeded long-term rates once again. A predictable harbinger of equity market corrections has been the inverted yield curve.

Economic contractions in gross domestic product (GDP), since 1977, have followed a period of the inversion of the yield curve. The timing of the decline in the GDP is usually between seven to 10 quarters after the inversion. If the inversion we saw in April is an indicator, we should be on our guard from the end of the third quarter of this year through the third quarter of 2021. Two other indicators to watch are dividend yields and the price earnings ratio. At the end of 2018, both had turned favorable. This is not the case now. The Dow Jones Industrial price earnings estimate that was 14.72 a year ago has risen to 19.09, while the dividend yield has dropped from 2.43 to 2.23. This means that stocks are pricier than they were a year ago.

The good news is that workers’ earnings are rising and consumers are spending more. Because consumers account for about 67% of the economy in the U.S. , these are good signs. The trade wars that created uncertainty and impacted businesses appear to be resolving. Congress has approved the revised trade agreement with Mexico and Canada. The impasse between China and the U.S. appears to be thawing. Commodity prices have moved up, which is usually a good sign of worldwide growth. World stock markets that had not been doing well have recovered.

Numbers Review

The S&P 500 ended the fourth quarter at 3231, up 254 points over the third quarter, for a gain of 8.5%. When this is added to the cumulative gain from the first three quarters of the year, we have a gain for the year of 28.9%.

The S&P Mid Cap index went from 1935 at the end of the third quarter to 2063, up 128 points, for a gain of about 6.6%. From the beginning of the year, when the index began at 1663, to the end of the year, this index is up 24.1%. Small cap stocks, as measured by the S&P Small Cap 600 index, were up 20.9% for the year.

Using the DJ Global ex U.S. index for international stocks, it rose 13.5% for the year.

Bonds, like stocks, had a solid gain for the year. The 10-year Treasury fell from 2.49% down to 1.91%, resulting in an investment gain. In a like manner, the Bloomberg Barclays US Aggregate Bond Index fell to 2.31%, for an 8.7% gain for the year.

Conclusion

With U.S. stocks up, international stocks up and bonds up, 2019 made for a nice year for investors.

Ed Mallon

Posted January 15, 2020