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Economic Flash – Walking a Tightrope through 2020

A growing list of uncertainties poses diverse threats to the financial markets in 2020. Among the biggest: the coronavirus, trade disputes, the US presidential election, US repo market liquidity, and the Iranian conflict. To date, all this has created only a slight uptick in volatility here and there, but the potential certainly exists for a more dramatic impact.

February 2020

US Economy: Consumers confident.

The US economy grew at an annual rate of 2.1% in Q4 2019 and 2.3% for all of 2019, the slowest pace in three years. While consumer confidence has remained at high levels not seen since 2000, the slight recent deterioration in consumer spending bears watching.

US Stocks: Large stocks lead.

Strong Q4 earnings reports from blue chip stocks, such as Amazon, Apple, GE and McDonalds, lifted large-cap equities, while small-cap stocks continued trailing. By the end of January, however, US equities had given up most or all of their gains amid higher volatility on coronavirus concerns.

Foreign Stocks: Rocky start.

Emerging markets continue to suffer as China tries to contain the Wuhan-originated coronavirus via trade and travel restrictions. Eurozone equities lagged on concern about a new US-Europe trade dispute, based on comments by President Trump at the World Economic Forum.

Fixed Income: Bonds rally.

As expected, the Fed kept its target interest rate unchanged at its January meeting. Still, the yield on 10-year US Treasury bonds fell to 1.5%, as investors worried about the impact of the coronavirus on China’s economy, which is now 15% of global GDP vs. about 5% in 2003 when the SARS epidemic occurred.

Real Assets: Infrastructure shines.

Most real assets performed poorly in January with commodities the weakest. Oil fell roughly 15% on expectations for weaker global growth and ample supply. Meanwhile, infrastructure equities, which are less economically sensitive, showed solid returns.

Alternatives: Modestly positive.

Hedge funds posted meager but generally positive returns, with managed futures capitalizing on trends within equities and energy. The equity market selloff at the end of January may give alternative strategies an opening to exploit relative value.

Equities Total Return

JAN 3 MOS. 1 YR
U.S. Large Cap 0.0% 6.7% 21.7%
U.S. Small Cap (3.2%) 3.7% 9.2%
U.S. Growth 2.0% 9.8% 26.9%
U.S. Value (2.4%) 3.4% 14.1%
Int’l Developed (2.1%) 2.2% 12.1%
Emerging Markets (4.7%) 2.3% 3.8%

Fixed Income Total Return

JAN 3 MOS. 1 YR
Taxable
U.S. Agg. Bond 1.9% 1.8% 9.6%
TIPS 2.1% 2.6% 9.2%
U.S. High Yield 0.0% 2.4% 9.4%
Int’l Developed 1.1% 0.1% 3.9%
Emerging Markets 0.2% 2.1% 5.5%
Tax-Exempt
Intermediate Munis 1.2% 1.8% 5.7%
Munis Broad Mkt 1.8% 2.3% 8.8%

Non-Traditional Assets Total Return

JAN 3 MOS. 1 YR
Commodities (7.4%) (5.2%) (5.4%)
REITs 1.3% 0.3% 16.8%
Infrastructure 1.6% 5.2% 18.7%
Hedge Funds
Absolute Return 0.1% 1.2% 3.2%
Overall HF Market 0.5% 2.8% 6.9%
Managed Futures 1.6% 1.9% 10.1%

Economic Indicators

JAN-20 OCT-19 JAN-19
Equity Volatility 18.8 13.2 16.6
Implied Inflation 1.6% 1.6% 1.9%
Gold Spot $/OZ $1589 $1513 $1321
Oil ($/BBL) $58 $60 $62
U.S. Dollar Index 90.8 92.4 91.1

Glossary of Indices

Our Take

We continue to be optimistic about the US and the global economy in the near term, and at this point believe the impact of the China-originated coronavirus will be contained, given government response efforts worldwide and China adding $170 billion to its economy as stimulus to counteract the economic drag. In the US, even if growth has slowed over the last few quarters, we don’t see a meaningful erosion of the steady consumer activity that has been the backbone of the economy. Also, corporate earnings, which we are watching closely, have been supportive of equity valuations, although 2020 is just getting started. Overseas, manufacturing and other forward-looking indicators have been better-than-expected. Still, the picture is less rosy, and new US trade complaints directed at Europe add another headwind for foreign developed markets, which have been in market and economic purgatory for the better part of the last decade.

While baseline economic forecasts call for roughly the same plodding pace of growth to which we’ve grown accustomed, a growing list of uncertainties poses diverse threats to the financial markets in 2020. The range of possible outcomes is large given potential shocks from the coronavirus, trade disputes, the US presidential election, US repo market liquidity, and the Iranian conflict, among the biggest concerns. To date, this long list of threats has created only a slight uptick in volatility here and there, but the potential certainly exists for a more dramatic impact.

What does this mean? Diversification is likely as important today as it ever was. With equity valuations elevated generally, and US equities in particular, it’s prudent to take steps to improve portfolio risk characteristics. We have been recommending modest portfolio adjustments to soften the potential downside, while highlighting the best return opportunities. Among our recommendations: increasing exposure to core fixed income and infrastructure equities, each of which have been additive to portfolios thus far. Investing always feels a bit like walking a tightrope and 2020 looks like it will offer some wobbles, but we are confident we are taking the right steps in making progress toward client objectives.

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