2019: A great year for stock markets around the world.
The S&P Index of 500 U.S. stocks reported a total return of 31.5% for 2019, which ranks as the index’s second best return of the last twenty years. Stock markets in other countries enjoyed equally strong returns with the MSCI All Country World Index (excluding U.S. stocks) appreciating 21.5%. It is important to place last year’s performance in a longer historical context since no one should be investing in stocks with only a one year time horizon. Over the past two years, the average return for U.S. stocks (the S&P 500 Index) was 7.1%; over the past five it was 8.4%. These represent more reasonable expectations for future stock returns.
U.S. bonds benefited from a drop in interest rates.
The U.S. Federal Reserve reversed its position last year and lowered short term rates three times. This was in response to slowing economic growth due to trade tensions and a lack of liquidity in overnight cash markets. While some economists viewed this monetary stimulus as unnecessary, it precipitated an unusual outcome: exceptional appreciation from both stock and bond markets in the same year. A more typical outcome has investors either bidding up stock prices in anticipation of growing corporate earnings or bidding up bond prices fearing recession and lower interest rates. While additional bond price gains are less likely in 2020, fixed income investments remain an important component of all portfolios, providing stable and predictable returns.
The U.S. economy is enjoying a period of stable, steady growth.
We are in a period of full employment, low inflation and with an economy expanding by 2% annually, after inflation. The impact of the Great Recession of a decade ago has receded but headwinds remain. U.S. population growth in 2019 was the slowest in a century. The U.S. Federal deficit will exceed a trillion dollars next year. Corporate earnings cannot increase materially faster than the overall economy over time. Competition between the two largest economies, the U.S. and China, will continue even though trade tensions have abated. There is also always the risk of unpredictable events.
The challenge of disciplined investing after an exceptionally good year.
Growing and preserving wealth over time is hard because of human nature. We are excited by 30% returns and want more stocks. We are scared by drops of 20% as we experienced at the end of 2018 and want less of them. Not reacting to our desires requires discipline. It is hard to push away the rest of that delicious dessert when full or skip the frivolous purchase in order to reach one’s savings goal for the month. Like managing your weight or your budget, investing requires the discipline to avoid increasing risk after good years or reducing it in anticipation of bad years.