Looking back on 2019, one thing is for sure: a lot happened. We ended the third quarter of 2019 with investor sentiment at 10-year lows, and now, three months later, we’re finding investor sentiment and the U.S. markets near all-time highs with the international markets rallying like they did in 2017, before the Trump tariff tweets began in January 2018.
It’s hard to understand how we got here. We closed out 2018 amid a deep correction, mentally bracing ourselves for three rate hikes in 2019; yet, instead of three hikes, we had three rate cuts in 2019 and few, if any, see the potential for rate hikes in the foreseeable future. Additionally, we started 2019 mired in a trade war with China; and it’s still going on, though now, we have a “Phase 1” trade agreement in place, but there are no expectations of a more robust trade deal before the November election.
Furthermore, despite the proverbial wall of worry, Wall Street partied like it was 1999! 2019 ranks as the sixth best year of returns for the S&P 500, with the index finishing the year up 31%. The international markets joined in with the Vanguard FTSE All-World ex-USA Index up 22%, and the iShares Emerging Markets Index closed out the year up 18%. Even the bond market posted stellar returns with the U.S. Bond AGG up 8%.
Now, after the tremendous returns of 2019, investors need to ask themselves at what point do valuations matter?
Judging by the growing cash hoard of Berkshire Hathaway, Inc., one of the largest American multinational-holding companies, that time is now. Warren Buffet, CEO and Chairman of Berkshire Hathaway, has accumulated over $125 billion of cash at the company, making it clear that valuations are too high for his liking.
Let’s take a look at one of my favorite slides from J.P. Morgan on the subject of valuations. This chart shows the forward PE ratio (price to earnings ratio) of the S&P 500 index over the last twenty-five years. The higher the number, the more expensive the market is, while a lower number indicates a cheaper or more reasonably priced market. The 25-year average of this indicator is 16.3. On the left side of the chart, you can see the forward PE reached 27.2 (indicating a very expensive market) leading up to the tech bubble in March of 2000. Around the middle of the chart, you can see the forward PE was 15.7 leading into the 2007-2009 recession. The market was actually reasonably priced at that time, though there was a lot of bad debt hiding in the banking system that posed deeper problems.
In March 2009, in the after-math of the recession, the forward PE was 10.3, indicating the market was very cheap at the time. Around that time, Warren Buffet wrote an op-ed in the NY Times telling everyone that the market was cheap, and he was buying stocks. Since that period, the market has become progressively more expensive. At the end of 2019, the forward PE was at 18.2, above the 25-year average of 16.3, indicating the market is no longer cheap but nowhere near the high valuations we witnessed during the tech bubble. Additionally, one could make the argument that a forward PE of 18.2 is reasonable in today’s low interest rate environment.
In terms of the U.S. economy, we’ve seen U.S. GDP continue to grow at a modest rate, and the December jobs report indicates employers are hiring at a steady pace. Job gains averaged 176,000 in 2019, a tremendous number 10 years into an economic recovery, pointing to steady economic growth heading into 2020. Employers have now added jobs for a record 10 years, which is the longest stretch seen in the eighty years this data has been tracked. At 3.5%, unemployment remains near historic lows, and December was the 22nd consecutive month with an unemployment rate of 4% or lower.
In terms of the global economy, despite the overhang of the trade wars, the World Bank estimates global growth for 2019 will come in around 2.4%; and although this would be the lowest level since 2008-2009, the World Bank projects global growth to uptick slightly to 2.5% in 2020, as trade pressures wane.
Now, you have heard me say the U.S. and Global economies continue to grow, the jobs market remains robust, interest rates remain very accommodative, and valuations, while creeping higher, may be justified in today’s low interest rate environment. So, what worries me? I mentioned that last year, Wall Street partied like it was 1999. That bothers me. Today, similar to 1999, right before the tech bubble burst, many tech stocks are moving higher on a daily basis, and analysts are responding by raising price targets, adding more fuel to the rally. To borrow a phrase from former Federal Reserve Chairman Alan Greenspan, this indicates a bit of “irrational exuberance” is entering the markets, which typically means we are moving closer to another meaningful correction. That being said, be prepared for such an occurrence – the markets do not move up in a straight line, and the occasional correction is healthy for the markets.
A final thought as we move into 2020: Despite potential volatility materializing on a global scale through Iran and the trade war with China and domestically in the Trump impeachment trial and 2020 election, we have learned throughout these past few years that such unpredictability is unavoidable and innate to the markets and the economy.
For long-term investors, nothing has changed. For the short- and intermediate-term investors – it is no longer clear sailing, as there are headwinds and crosswinds out there amidst a U.S. market that, at a minimum, is fully valued. Nonetheless, both the markets and the economy have weathered similar storms quite well these past few years, and we expect that to continue as long as monetary policy remains accommodative and inflation stays in check.
Securities and Advisory Services offered through Commonwealth Financial Network, Member FINRA/SIPC, a Registered Investment Adviser.