Coronavirus Update from Commonwealth CIO Brad McMillan, May 22, 2020

Brad McMillan, Commonwealth’s CIO, gives an update on the coronavirus pandemic, including its effects on the economy and markets. There was some good news on the pandemic front, with daily testing numbers continuing to rise. We didn’t see as much progress in the daily spread rate and the number of new cases, with both remaining relatively stable. Here, the results may be better than they look, as we didn’t get a bump in new cases even though the economy started to reopen. In fact, the economic reopening seems to be going better than many expected. The restaurant business has started to tick up, and mortgage applications have just about returned to 2019 levels. With all signs pointing to a recovery that’s well on track, could recent market volatility be behind us? Watch this video to learn more. Follow Brad at blog.commonwealth.com/independent-market-observer.

Coronavirus Update from Commonwealth CIO Brad McMillan, May 8, 2020

Brad McMillan, Commonwealth’s CIO, takes a look back over the past month to evaluate how far we’ve come in the coronavirus crisis. We’ve seen real progress in terms of the pandemic, with daily spread rates going from 15 percent at the start of April to less than 3 percent in recent days. Plus, the daily testing rate has doubled in that same time period, with the number of positive test results declining. We’re also making progress on the economic front. The news here isn’t necessarily good, but we could say it’s getting less bad. Weekly layoffs have started to trend down, federal stimulus programs have gone into effect, and a number of states have begun to reopen. The markets have taken note of these shifts and fully expect a V-shaped recovery. So, are we now at the end of the beginning? Watch this video to learn more. Follow Brad at blog.commonwealth.com/independent-market-observer.

Coronavirus Update from Commonwealth CIO Brad McMillan, May 1, 2020

Brad McMillan, Commonwealth’s CIO, discusses where we are in the coronavirus crisis, including a look at the virus itself, the economy, and the market. We had some good news this past week in terms of the virus. The daily case growth rate dropped to under 3 percent per day, and the number of tests given per day increased. Unfortunately, there was bad news for the economy, with millions more people losing their jobs. Even here, however, there are signs that the federal stimulus programs are working, and the peak of the economic damage may be behind us. In fact, the stock market seems to think the recovery may happen sooner rather than later. It is pricing in a V-shaped recovery, with a return to something close to normal by the start of next year. Does the market have it right? Watch this video to learn more. Follow Brad at blog.commonwealth.com/independent-market-observer.

Coronavirus Update from Commonwealth CIO Brad McMillan, April 24, 2020

Brad McMillan, Commonwealth’s CIO, discusses where we are in the coronavirus crisis and what that means for the economy and markets. We’ve seen significant progress in terms of the virus, with the daily case growth rate dropping below 4 percent for several days in a row. Further, the number of tests given has risen from about 150,000 to 300,000 per day. As we turn to the economy, the news is more of a mixed bag. Jobless claims are still very high, although this damage may have started to peak. Plus, with measures like the Paycheck Protection Program and stimulus checks, both individuals and businesses are getting some much-needed relief. Given these signs of improvement, the market seems to be saying the economic recession won’t be as bad as was originally anticipated. But what does all this mean for reopening states and the economy? Watch this video to learn more. Follow Brad at blog.commonwealth.com/independent-market-observer.

Market Update for the Quarter Ending March 31, 2020

Shocking month ends terrible quarter
March was another terrible month for stocks, capping off a turbulent quarter. The continued spread of the novel coronavirus led to even more fear and uncertainty in global markets. The S&P 500 declined by 12.35 percent for the month and 19.60 percent for the quarter. The Dow Jones Industrial Average (DJIA) did even worse, dropping by 13.62 percent for the month and 22.73 percent for the quarter. The Nasdaq Composite performed the best, but it still lost 10.03 percent in March, contributing to a 13.95 percent decline for the quarter.

These poor results came despite improving historical fundamentals. Per Bloomberg Intelligence, as of March 20, the blended average earnings growth rate of the S&P 500 for the fourth quarter of 2019 stood at 1.4 percent, with 99.6 percent of companies reporting. This is a solid improvement from the initial estimate of a 1.2 percent decline. It marks the first quarter with year-over-year earnings growth since the fourth quarter of 2018. Normally, this would be news worth celebrating. But with the shutdown of the U.S. economy and others around the world, past earnings growth is now much less relevant. Investors face significant uncertainty over what future earnings will be.

Technical factors displayed the breakdown in investor confidence. All three major indices ended the month below their respective 200-day moving averages. This result marked the second month in a row below this important trendline for both the S&P 500 and the DJIA. The Nasdaq Composite was a bit more resilient and managed to finish February above its trendline. But the selling pressure in March brought this index below the trendline by midmonth, where it stayed until month-end. This is an important technical signal, as prolonged breaks below this trendline could indicate a longer-term shift in investor sentiment.

Internationally, we saw large declines, as coronavirus case counts around the world spiked. The MSCI EAFE Index dropped by 13.35 percent for the month, leading to a loss of 22.83 percent for the quarter. Emerging markets fell by even more, dropping 15.38 percent for the month and 23.57 percent for the quarter. Beyond the viral crisis, international markets also suffered from rising dollar strength and falling oil prices. Technicals for international markets remained weak, as both indices finished March well below their respective 200-day moving averages for the second month in a row.

To some extent, investment-grade fixed income benefited from the global uncertainty during the quarter, but even here there was significant volatility. Investors fled to safe assets like fixed income, driving down interest rates. Rates were reduced even further by the Federal Reserve’s (Fed’s) March decision to effectively cut the federal funds rate to zero. As a result, the 10-year Treasury note dropped from 1.88 percent at the start of the year to 0.70 percent at the end of the quarter.

The sudden decline in rates disrupted financial markets. This led investors to flee to cash, which sent fixed income prices down, although they had largely recovered by month-end. The Bloomberg Barclays U.S. Aggregate Bond Index fell by 0.59 percent during the month, but it gained 3.15 percent during the quarter. High-yield fixed income, which tends to be more closely correlated with equities than with interest rates, fell by 11.46 percent for the month, contributing to a 12.68 percent decline for the quarter.

Coronavirus’s impact on American workers
Concerns about the coronavirus pandemic roiled markets in March, as the world came to grips with the severity of the situation. Mandatory shutdowns of schools, restaurants, sporting events, and most nonessential businesses drove home the real-world impact the coronavirus is having on daily life.

The social impact was immediate, but the economic effects only got started during March. The first data release to reflect the damage was the weekly initial jobless claims report for the week ending March 21. As you can see in Figure 1, 3.283 million Americans filed for unemployment. This was the highest weekly total of all time, well above the 665,000 we saw in March 2009 at the height of the financial crisis. This economic shock is what drove investors out of stocks and toward safer assets. With the social lockdown measures also shutting down large parts of the economy, it is almost impossible to tell what the full extent of the damage will be.

Figure 1. Weekly Initial Jobless Claims, 2005–Present

chart
Source: Bloomberg

Fortunately, both the Fed and the federal government have stepped in to help keep the economy alive until it can restart. The Fed cut rates to zero and started a new round of quantitative easing, while the federal government put a $2 trillion stimulus plan in place to support worker incomes and small businesses.

This coordinated fiscal and monetary stimulus should help support the economy through the period of large-scale social distancing. In addition, another stimulus bill is already underway that would provide relief for states and individuals, as well as targeted support for the mortgage and travel industries.

The policy response to the coronavirus crisis in March is unprecedented in both magnitude and speed. The pandemic and the economic shutdown are damaging and will likely result in a recession. But the supporting measures, both current and pending, should keep the economy on life support until the country opens again. The financial markets seem to agree with this take, as the policy actions led to a partial recovery toward the end of the month.

The end of the beginning?
Although conditions remain difficult, there is some positive news as well. Here in the U.S., we have the benefit of watching how other countries have dealt with outbreaks. In places like South Korea and China, we have seen the positive impact enhanced testing and strict social distancing practices can have on slowing the spread of the virus and flattening the curve. We know what has to be done and are doing it across the country—and there is reason to believe it is working.

A good sign is that the number of new cases in the U.S. is growing more slowly. According to Worldometer, the growth rate has dropped by half. As we have seen in other countries, the decline in the growth rate of new cases is a necessary first step to stopping the spread. We are still far from containing the coronavirus outbreak in the U.S., but at least there is evidence that we are on the right track.

Financial markets are also staging a partial recovery, suggesting that the worst of that reaction may be behind us. While there will certainly be volatility—and markets may well drop again—we’re seeing signs that much of the panic has passed, and markets are now reflecting a balance of hope and fear.

Risks are here to stay
As we saw throughout the month and quarter, risks to economic growth and markets can spring up at any time and from anywhere. Given the nature of the coronavirus, we will see rising case numbers and deaths in the upcoming weeks. The economic updates will be grim as well. And looking forward, there is still a lot of uncertainty about the measures taken to combat the virus, which will likely drive further volatility.

There are very real reasons for hope, however, with signs that containment measures are having a positive effect domestically. The coordinated response from the federal government is also a positive for the economy and markets in these trying times. And with the large declines we’ve seen so far this year, markets are now pricing in a much broader pandemic and a tremendous amount of economic damage—things that may not materialize.

The economy and markets are now driven by reactions to the spread of the coronavirus and the government’s policy response. Although there are indeed signs of improvement, current conditions remain challenging and are likely to get worse before they get better. As investors, we need to remain focused on the long term. The coronavirus crisis is just the latest in a long line of events that will ultimately be overcome, but it is impossible to know how and when. Given that, and the volatile times we are in, maintaining a well-diversified portfolio that matches your goals and time horizon remains the best path forward.

Co-authored by Brad McMillan, managing principal, chief investment officer, and Sam Millette, senior investment research analyst, at Commonwealth Financial Network.

All information according to Bloomberg, unless stated otherwise.

Disclosure: Certain sections of this commentary contain forward-looking statements based on our reasonable expectations, estimates, projections, and assumptions. Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict. Past performance is not indicative of future results. Diversification does not assure a profit or protect against loss in declining markets. All indices are unmanaged and investors cannot invest directly into an index. The Dow Jones Industrial Average is a price-weighted average of 30 actively traded blue-chip stocks. The S&P 500 Index is a broad-based measurement of changes in stock market conditions based on the average performance of 500 widely held common stocks. The Nasdaq Composite Index measures the performance of all issues listed in the Nasdaq Stock Market, except for rights, warrants, units, and convertible debentures. The MSCI EAFE Index is a float-adjusted market capitalization index designed to measure developed market equity performance, excluding the U.S. and Canada. The MSCI Emerging Markets Index is a market capitalization-weighted index composed of companies representative of the market structure of 26 emerging market countries in Europe, Latin America, and the Pacific Basin. It excludes closed markets and those shares in otherwise free markets that are not purchasable by foreigners. The Bloomberg Barclays Aggregate Bond Index is an unmanaged market value-weighted index representing securities that are SEC-registered, taxable, and dollar-denominated. It covers the U.S. investment-grade fixed-rate bond market, with index components for a combination of the Bloomberg Barclays government and corporate securities, mortgage-backed pass-through securities, and asset-backed securities. The Bloomberg Barclays U.S. Corporate High Yield Index covers the USD-denominated, non-investment-grade, fixed-rate, taxable corporate bond market. Securities are classified as high-yield if the middle rating of Moody’s, Fitch, and S&P is Ba1/BB+/BB+ or below.


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Market Update for the Month Ending February 29, 2020

A turbulent February for markets
February was a tough month for markets, ending in a terrible final week—the worst week for U.S. equity market returns since 2008. Investors were spooked by news about the spread of the coronavirus and fled to safe-haven assets. The S&P 500 fell by 8.23 percent, the Dow Jones Industrial Average (DJIA) dropped by 9.75 percent, and the Nasdaq Composite lost 6.27 percent.

This sell-off came despite positive fundamentals, with fourth-quarter earnings for the S&P 500 continuing to come in above expectations. Per Bloomberg Intelligence, as of February 20, the blended average earnings growth rate for the S&P 500 stands at 1.3 percent for the fourth quarter, with 86 percent of companies reporting. This is a solid improvement from initial estimates of a 1.2 percent decline. If this growth rate holds, it would represent the first quarter with year-over-year earnings growth since the fourth quarter of 2018. While prices can diverge from fundamentals over the short term, fundamentals drive growth in the long term. So, this return to growth is a positive development for markets.

Technicals were far less supportive for U.S. equities during the month. Both the S&P 500 and DJIA ended below their respective 200-day moving averages. The Nasdaq Composite was the only major equity index that finished above its trendline. It traded below this level on the final trading day of the month, however, before recovering and finishing above trend. This is an important technical signal, as prolonged breaks below this trendline could indicate a longer-term shift in investor sentiment.

The story was much the same internationally, with the MSCI EAFE Index falling by 9.04 percent for the month and emerging markets declining by 5.27 percent, both due to coronavirus concerns. Technicals were a headwind for international markets, with both indices finishing below their respective 200-day moving averages.

The major beneficiary from the risk-off sentiment was investment-grade fixed income. Investors sold out of riskier asset classes and flocked to the relative safety of bonds. Yields fell sharply, as shown by movements in the 10-year Treasury yield, which started February at 1.54 percent and finished at 1.13 percent. Falling yields drove the Bloomberg Barclays U.S. Aggregate Bond Index to a gain of 1.80 percent.

High-yield fixed income, which tends to be more closely correlated with equities than with interest rates, did not fare as well. The Bloomberg Barclays U.S. Corporate High Yield Index was positive for much of the month. But the risk-off sentiment that pervaded markets hit high-yield bonds near month-end, causing a decline of 1.41 percent. Investors demanded more yield to compensate for perceived higher levels of risk. As a result, credit spreads for high-yield bonds widened to levels last seen in June 2019.

Putting volatility in perspective
Concerns about the spread of the coronavirus were the major driver of market volatility in February. In January, investors were focused largely on the spread of the disease in China and the steps governments around the world were taking to contain it. But in February, news that the virus had spread throughout much of the world spurred fears of a pandemic. Reports of untraceable cases and the first death from the virus in the U.S. drove this point home for Americans.

Market reactions to this larger-scale problem were severe, as was the case with previous epidemics, such as Ebola, Zika, and SARS. In that sense, while the risks are real, we have seen this movie before. There’s certainly no guarantee things will play out as they have in the past. But with each of these epidemics, we saw short-term volatility followed by quick recovery once the disease was contained. Data from China and other countries around the world shows that, so far, the spread of the coronavirus is moderating. So, it is not unreasonable to expect a similar market recovery once more progress is made.

Economic updates positive, despite coronavirus threat
While investor attention was dominated by the sell-off at month-end, many of the economic updates released during the month showed signs of an improving economy. February’s consumer confidence reports were encouraging, with both major measures of consumer sentiment increasing to multi-month highs. The University of Michigan consumer sentiment survey was especially encouraging. It included survey responses from consumers through February 25, when markets were experiencing the virus-related sell-off. So far, consumer sentiment has remained resilient despite the spread of the virus. We will be monitoring this closely, however, given the close relationship between consumer confidence and spending.

Speaking of spending, consumer spending data released during the month was solid as well. Headline retail sales grew 0.3 percent in January, marking the fourth straight month of headline sales growth. Housing sales were also impressive, with existing home sales up nearly 10 percent year-over-year. New home sales were even more notable, increasing by 7.9 percent. This brought the pace of new home sales up to its highest monthly level since 2007, as you can see in Figure 1. Overall, February’s data releases showed the American consumer was very active to start the year.

Figure 1. New Home Sales, 2007–Present

chart

Businesses also showed improving confidence and spending figures. Both manufacturer and nonmanufacturer confidence increased by more than expected in January. Durable goods orders came in better than expected for both December and January. Core durable goods orders, which are a proxy for business investment, increased for the third straight month. This indicates the slowdown we saw in business investment throughout much of 2019 may be reversing. Although they could be at risk going forward, these positive economic fundamentals provide a substantial cushion for any economic damage from the virus.

Fundamentals vs. risks
Despite the strong fundamentals we saw during the month, risks remain, and more volatility is likely. Previous epidemics have had minimal long-term effects on markets, but there is no guarantee this outbreak will follow the same pattern.

That said, markets are now pricing in quite a bit of risk, and there is potential for good news to lead to a market rally. We’ve already seen some evidence of this in China, where reports of a slowdown in new cases led to a partial recovery in equity markets at month-end. In the U.S., fundamentals and spending are strong. So, we can still expect economic growth to continue in 2020. There is also the potential for market support from global central banks. They are monitoring the spread of the virus carefully and will be ready to step in with supportive monetary policy if necessary.

Ultimately, the major risk to the economy is the potential for a sharp drop in confidence in the face of the negative headlines. We will be watching this going forward. Given the likelihood of further short-term volatility, February’s results remind us of the importance of constructing portfolios that can withstand volatility. As always, a well-diversified portfolio that matches investor goals and time horizons remains the best path forward.

Co-authored by Brad McMillan, managing principal, chief investment officer, and Sam Millette, senior investment research analyst, at Commonwealth Financial Network.

All information according to Bloomberg, unless stated otherwise.

Disclosure: Certain sections of this commentary contain forward-looking statements based on our reasonable expectations, estimates, projections, and assumptions. Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict. Past performance is not indicative of future results. Diversification does not assure a profit or protect against loss in declining markets. All indices are unmanaged and investors cannot invest directly into an index. The Dow Jones Industrial Average is a price-weighted average of 30 actively traded blue-chip stocks. The S&P 500 Index is a broad-based measurement of changes in stock market conditions based on the average performance of 500 widely held common stocks. The Nasdaq Composite Index measures the performance of all issues listed in the Nasdaq Stock Market, except for rights, warrants, units, and convertible debentures. The MSCI EAFE Index is a float-adjusted market capitalization index designed to measure developed market equity performance, excluding the U.S. and Canada. The MSCI Emerging Markets Index is a market capitalization-weighted index composed of companies representative of the market structure of 26 emerging market countries in Europe, Latin America, and the Pacific Basin. It excludes closed markets and those shares in otherwise free markets that are not purchasable by foreigners. The Bloomberg Barclays Aggregate Bond Index is an unmanaged market value-weighted index representing securities that are SEC-registered, taxable, and dollar-denominated. It covers the U.S. investment-grade fixed-rate bond market, with index components for a combination of the Bloomberg Barclays government and corporate securities, mortgage-backed pass-through securities, and asset-backed securities. The Bloomberg Barclays U.S. Corporate High Yield Index covers the USD-denominated, non-investment-grade, fixed-rate, taxable corporate bond market. Securities are classified as high-yield if the middle rating of Moody’s, Fitch, and S&P is Ba1/BB+/BB+ or below.

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Market Update for the Month Ending January 31, 2020

Coronavirus outbreak leads to mixed results for markets
January was a mixed month for markets, with concerns about the spread of the Wuhan coronavirus having a negative effect at month-end. Despite spending most of the month in positive territory, both the S&P 500 and the Dow Jones Industrial Average declined. The former fell 0.04 percent while the latter dropped 0.89 percent. The Nasdaq Composite also saw some late-month volatility, but previous gains were strong enough to leave the index up 2.03 percent for the month.

Despite the rocky ending to the month, fundamentals may be showing signs of improvement. Per Bloomberg Intelligence, as of January 31, the blended year-over-year earnings growth estimate for the S&P 500 in the fourth quarter is –0.3 percent. If this estimate holds, it would mark four straight quarters with earnings declines. The situation has been improving, however, and analysts are currently forecasting a return to growth in the first quarter of 2020. Fundamentals drive market returns, so earnings growth this quarter would create a tailwind for future returns. From a technical perspective, all three major U.S. indices remained well above their respective 200-day moving averages.

International markets had a tough start to the year, facing more volatility than their U.S. counterparts. The MSCI EAFE Index fell by 2.09 percent in January, with much of the decline coming in the final week of the month. The MSCI Emerging Markets Index faced pressure as well, falling 4.66 percent. Concerns about the coronavirus and the effect it could have on China’s growth were the primary causes. Both indices remained above their 200-day moving averages, though, indicating continued investor support.

The broad fixed income market, on the other hand, had a very strong start to the year, as the general risk-off sentiment drove investors into safe-haven assets. Long-term U.S. Treasury yields fell sharply in January. The 10-year yield declined from 1.88 percent at the start of the month to 1.51 percent at month-end. This brought yields on the long end of the curve back down to October lows and drove the Bloomberg Barclays U.S. Aggregate Bond Index to a gain of 1.92 percent.

Although investment-grade fixed income started the year off well, the same can’t be said for high-yield bonds. This portion of the fixed income market is typically not driven much by movements in interest rates; rather, it’s more correlated with equities, due to the speculative nature of high-yield bonds. High-yield spreads increased notably during the month, as investors demanded greater yield to compensate for the additional credit risk. The Bloomberg Barclays U.S. Corporate High Yield Index inched up by 0.03 percent.

Shifting geopolitical risks affect markets
January provided a prime example of why it is important to expect the unexpected and construct portfolios that can withstand short-term market volatility. Throughout the month, several geopolitical risks grabbed headlines and rocked markets.

The most significant was the discovery and spread of the coronavirus, which was declared a public health emergency by the World Health Organization at the end of January. Governments around the world have taken swift action to work toward halting the spread of the disease. Still, it has been the major driver of global market volatility.

Here in the U.S., the spread of the virus appears to be contained for now, so the effect on public health has been minimal. The potential economic impact is not yet clear, however. So far, travel and technology companies have been hit the hardest. But as we saw with the market sell-off at the end of the month, investors were also spooked by the continued spread of the disease and general uncertainty created by the situation. Ultimately, we can’t predict what the final economic cost and public health implications will be, so we can expect to see more volatility in line with the headlines.

Another major news story during the month was the escalation of military tensions between the U.S. and Iran. Notably, a U.S. strike killed an Iranian general in Iraq. It was followed by the retaliatory strike from Iran on two Iraqi airbases that were housing American military personnel. This unexpected development captured global attention due to the potential for further escalation in the war-torn region. Although this story was in the headlines for more than a week, its effect on financial markets was short-lived.

Both of these events showed how unexpected risks can grab investors’ attention and lead to market gyrations. As we saw with the Iran situation, though, once more clarity becomes available, markets can recover swiftly from these short-term jolts. Therefore, building a portfolio that can withstand the occasional bout of volatility should be an important goal for any investor.

Economic data improves
Despite the news-driven market turmoil we saw at month-end, the economic data releases in January continued to show improving fundamentals in the U.S. After staying rangebound for much of the fourth quarter, both major surveys of consumer confidence climbed by more than expected in January. A strong jobs market and increased optimism about future equity market returns drove much of this better-than-expected result. High consumer confidence often leads to additional consumer spending. So, seeing both confidence measures increase bodes well for first-quarter growth.

Consumer spending data was healthy, with the most recent retail sales report showing 0.3 percent growth in December. This brought year-over-year growth up to 5.8 percent, the highest it’s been since August 2018. Headline sales figures were held back by slow auto sales, though. Excluding cars, retail sales increased by a strong 0.7 percent in December, the best monthly result since July. Even though these retail sales results were strong, it was the housing sector that truly impressed.

Housing continues to be a bright spot in the economic expansion. Low mortgage rates and high consumer confidence have driven prospective buyers into the market. Existing home sales increased by more than expected during the month, reaching the highest level since February 2018. Even this strong result was likely held back due to lack of supply; existing homes available for sale have declined for seven straight months and are down 8.5 percent year-over-year.

Declining supply is a headwind for potential home buyers, but it has been a boon for builders, who ramped up construction at the end of 2019.

As you can see in Figure 1, housing starts grew dramatically at year-end, reaching post-recession highs. Home builder confidence remains near 20-year highs, driven by buyer foot traffic at levels last seen in 1998. We’ve already begun to feel the positive effects from this building spree on the economy. Residential investment grew at the fastest rate in two years in the fourth quarter, and it was a positive contributor to fourth-quarter gross domestic product growth. The housing sector has an outsize effect on the economy due to the associated knock-on purchases that come with buying a house. So, the rebound we saw at the end of 2019 is very welcome, and we appear to be poised for continued growth in the new year.

Figure 1. Housing Starts 2007–Present

chart

Economy continues to grow, but risks remain
January showed how important it is to be aware that risks to financial markets can strike suddenly and without warning. The volatility we experienced at month-end was caused in large part by fear of the unknown, which can rock markets at any time.

From an economic perspective, the strong consumer surveys point to future spending growth. As long as consumers remain willing and able to spend, the economic expansion will likely continue, given the importance of the American consumer to overall economic health.

Remember, there is always the potential for suddenly emerging risks to affect markets, even when the economic environment is positive. That’s why a well-diversified portfolio that matches investor goals and time horizons remains the best path forward.

Co-authored by Brad McMillan, managing principal, chief investment officer, and Sam Millette, senior investment research analyst, at Commonwealth Financial Network.

All information according to Bloomberg, unless stated otherwise.

Disclosure: Certain sections of this commentary contain forward-looking statements based on our reasonable expectations, estimates, projections, and assumptions. Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict. Past performance is not indicative of future results. Diversification does not assure a profit or protect against loss in declining markets. All indices are unmanaged and investors cannot invest directly into an index. The Dow Jones Industrial Average is a price-weighted average of 30 actively traded blue-chip stocks. The S&P 500 Index is a broad-based measurement of changes in stock market conditions based on the average performance of 500 widely held common stocks. The Nasdaq Composite Index measures the performance of all issues listed in the Nasdaq Stock Market, except for rights, warrants, units, and convertible debentures. The MSCI EAFE Index is a float-adjusted market capitalization index designed to measure developed market equity performance, excluding the U.S. and Canada. The MSCI Emerging Markets Index is a market capitalization-weighted index composed of companies representative of the market structure of 26 emerging market countries in Europe, Latin America, and the Pacific Basin. It excludes closed markets and those shares in otherwise free markets that are not purchasable by foreigners. The Bloomberg Barclays Aggregate Bond Index is an unmanaged market value-weighted index representing securities that are SEC-registered, taxable, and dollar-denominated. It covers the U.S. investment-grade fixed-rate bond market, with index components for a combination of the Bloomberg Barclays government and corporate securities, mortgage-backed pass-through securities, and asset-backed securities. The Bloomberg Barclays U.S. Corporate High Yield Index covers the USD-denominated, non-investment-grade, fixed-rate, taxable corporate bond market. Securities are classified as high-yield if the middle rating of Moody’s, Fitch, and S&P is Ba1/BB+/BB+ or below.

Market Update for the Quarter Ending December 31, 2019

Strong December caps off terrific year for markets
What a difference a year can make. At the end of 2018, markets were selling off due to political concerns, and the year finished on a sour note. But 2019 had a significantly better ending for investors. Markets experienced solid gains in December, capping off an impressive quarter and year. All three major U.S. indices were up for the month; the S&P 500 returned 3.02 percent, the Dow Jones Industrial Average (DJIA) gained 1.87 percent, and the Nasdaq Composite rose 3.63 percent. This positive performance led to a quarterly gain of 9.07 percent for the S&P 500, 6.67 percent for the DJIA, and 12.47 percent for the Nasdaq. The annual figures are even more impressive, with the S&P returning 31.49 percent, while the DJIA and Nasdaq grew by 25.34 percent and 36.69 percent, respectively.

This strong performance came despite weak fundamentals. Per Bloomberg Intelligence, earnings for the S&P 500 fell by 1.2 percent during the third quarter, which marks the second straight quarter with declining earnings. Although this result was disappointing, it was better than anticipated, as analysts originally forecasted a decline of 3.6 percent. Looking forward, analysts expect earnings to decline in the fourth quarter before returning to growth in the first quarter of 2020. Over the long term, fundamentals drive performance, so a return to earnings growth would be a boon for equity markets. From a technical perspective, markets were well supported, with all three indices spending the entire month and quarter above their respective 200-day moving averages.

International markets also had a strong month, quarter, and year, despite suffering from more volatility than their domestic counterparts. The MSCI EAFE Index gained 3.25 percent in December, which contributed to a quarterly gain of 8.17 percent and an annual return of 22.01 percent. The MSCI Emerging Markets Index had a very strong end to the year, gaining 7.53 percent for the month, 11.93 percent for the quarter, and 18.90 percent for the year. From a technical perspective, both the developed and emerging market indices spent time below their trendlines in October, but they recovered and spent November and December comfortably above their 200-day trend lines.

Fixed income had a more challenging month, as rising rates put a damper on returns. The 10-year Treasury yield ended November at 1.78 percent and fell as low as 1.72 percent during the month before finishing December at 1.92 percent. The volatile rate environment caused the Bloomberg Barclays U.S. Aggregate Bond Index to fall by 0.07 percent in December. The index returned 0.18 percent for the quarter and a more impressive 8.72 percent for the year, as long-term rates fell significantly in 2019.

High-yield bonds, which are typically less affected by changes in interest rates, had positive results over the past month, quarter, and year. The Bloomberg Barclays U.S. Corporate High Yield Index returned 2 percent in December, leading to a quarterly gain of 2.61 percent and an annual return of 14.32 percent. High-yield spreads tightened during the course of the year, falling from 5.35 percent at the start of January to 3.60 percent at the end of December.

Economic growth continues
December’s economic updates continued to paint a picture of steady growth for the economy. Third-quarter gross domestic product (GDP) showed the economy growing at an annualized rate of 2.1 percent, which was much better than initial economist estimates of 1.6 percent. This result was also an improvement on the second quarter, when GDP grew at a 2 percent annualized rate. Although third-quarter growth came in below the 3.1 percent growth rate we saw in the first quarter of 2019, this better-than-expected result helped calm concerns of a more serious slowdown for the economy.

The major driver of economic growth in the third quarter was consumer spending, with personal consumption growing at an annualized rate of 3.2 percent during the quarter. Although this is down from the 4.1 percent growth rate in the second quarter, it’s better than initial estimates of 2.9 percent annualized growth.

In addition, data released in December showed that consumer spending continued to grow in the fourth quarter. For example, November’s personal income and spending reports highlighted the strength in spending growth we saw in 2019. The 0.4 percent increase in November’s personal spending marked the ninth straight month of growth, including solid 0.3 percent growth in October. Consumer spending growth was well supported by personal income growth throughout the year as well, indicating that spending increases in 2019 are sustainable as we head into 2020. Spending growth was driven by high consumer confidence, which, in turn, was buoyed by a better-than-expected November jobs report and equity markets setting all-time highs throughout the month.

Looking forward, the three rate cuts from the Federal Reserve (Fed) in 2019 should help spur additional spending growth in the new year. Lowered interest rates allow consumers to spend more, especially on big-ticket items like cars and houses. We’ve already seen the positive effect lowered rates can have on the housing market, which experienced a rebound following a slowdown in 2018 and early 2019.

Rebound in housing marches on
The housing sector of the economy has been one of the bright spots in the current economic expansion over the past two quarters. High consumer confidence and lowered mortgage rates have drawn additional home buyers into the market, driving up sales of both existing and new homes. New home sales have been especially impressive; they hit their highest monthly level since 2007 in November, putting them up more than 18 percent on a year-over-year basis.

Home builders have benefited from the increased demand for housing, with home builder confidence rising to a 20-year high to end the year. As you can see in Figure 1, this is a very impressive rebound following a decline to a three-year low at the end of 2018. Home builders have backed up this increased confidence by building more, with November’s housing starts representing the second-highest monthly level since 2007.

Figure 1. NAHB Housing Market Index, 1999–Present

chart
Source: National Association of Home Builders

As we saw during the most recent recession, the housing sector can have an outsize effect on the overall economy. So, this turnaround in the second half of 2019 is very encouraging as we head into the new year.

Risks continue to shift
Despite the strength in consumer spending we saw in 2019, very real risks to economic expansion remain. Business confidence continued to disappoint, with both the Institute for Supply Management Manufacturing and Nonmanufacturing indices unexpectedly declining in November. Manufacturing confidence has been especially disappointing, with the index remaining in contractionary territory for the past four months. Business investment has also been weaker than expected, as evidenced by November’s durable goods orders, which fell by 2 percent against expectations for a 1.5 percent increase. Although business confidence and spending were disappointing throughout 2019, there is the potential for a rebound in 2020, given continued progress with the trade talks between the U.S. and China.

Speaking of trade, the announcement of a preliminary “phase one” trade deal between the U.S. and China midmonth was a clear de-escalation in the ongoing trade war, even if the direct economic impact from the agreement may be minimal. At the very least, this agreement shows a willingness from both sides to continue to negotiate and makes additional tariffs seem unlikely for the time being. Although trade war-related risks may have decreased during the month, as we saw throughout 2019, these trade negotiations are a politically charged process that have the potential to affect markets at any time. The ongoing protests in Hong Kong and their increasing relevance in trade talks are an example of the unpredictable nature of this complex situation.

Another major political development in December was the general election in the U.K. Prime Minister Boris Johnson’s Conservative party consolidated power in advance of the January 31 deadline for the U.K.’s formal exit from the European Union. The ongoing negotiations on the terms of this exit will likely continue to serve as a potential source of volatility for international markets as we approach the latest deadline.

Finally, while they have not yet had a direct effect on markets, the ongoing impeachment proceedings in the U.S. still have the potential to create volatility. Previous impeachment proceedings have created short-term market disruptions, so this is certainly something to watch for—especially if a trial in the Senate becomes a drawn-out affair that creates uncertainty for market participants. For the time being, impeachment is not a major driver of volatility for markets, but it may become one in the future and should be monitored.

Better year than expected
All things considered, 2019 was a better year for markets and the economy than expected amid all the doom and gloom at the end of 2018. Strong consumer spending helped power further market gains here at home, even though lowered business investment and confidence remain areas of concern. Compared with where we were last year—with predictions of a recession and markets showing red for the year—2019 turned out much better than expected and puts us in a good position for growth in 2020.

Although we may have experienced a bit of a slowdown earlier in the year, slow growth is still growth and should be welcomed. Looking forward, continued support from the Fed, along with the anticipated return to earnings growth in 2020, should allow for continued market gains. With that being said, real risks to this outlook remain, especially politically. An unexpected result from the ongoing U.S.-China trade talks or further delays to the Brexit process could certainly lead to market volatility.

Despite the potential for future short-term market disruptions, the healthy economic fundamentals should support markets in the new year. Volatility has the potential to cause short-term pain for investors, but a well-diversified portfolio that matches investor goals and time horizons remains the best path forward.

Co-authored by Brad McMillan, managing principal, chief investment officer, and Sam Millette, senior investment research analyst, at Commonwealth Financial Network.

All information according to Bloomberg, unless stated otherwise.

Disclosure: Certain sections of this commentary contain forward-looking statements based on our reasonable expectations, estimates, projections, and assumptions. Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict. Past performance is not indicative of future results. Diversification does not assure a profit or protect against loss in declining markets. All indices are unmanaged and investors cannot invest directly into an index. The Dow Jones Industrial Average is a price-weighted average of 30 actively traded blue-chip stocks. The S&P 500 Index is a broad-based measurement of changes in stock market conditions based on the average performance of 500 widely held common stocks. The Nasdaq Composite Index measures the performance of all issues listed in the Nasdaq Stock Market, except for rights, warrants, units, and convertible debentures. The MSCI EAFE Index is a float-adjusted market capitalization index designed to measure developed market equity performance, excluding the U.S. and Canada. The MSCI Emerging Markets Index is a market capitalization-weighted index composed of companies representative of the market structure of 26 emerging market countries in Europe, Latin America, and the Pacific Basin. It excludes closed markets and those shares in otherwise free markets that are not purchasable by foreigners. The Bloomberg Barclays Aggregate Bond Index is an unmanaged market value-weighted index representing securities that are SEC-registered, taxable, and dollar-denominated. It covers the U.S. investment-grade fixed-rate bond market, with index components for a combination of the Bloomberg Barclays government and corporate securities, mortgage-backed pass-through securities, and asset-backed securities. The Bloomberg Barclays U.S. Corporate High Yield Index covers the USD-denominated, non-investment-grade, fixed-rate, taxable corporate bond market. Securities are classified as high-yield if the middle rating of Moody’s, Fitch, and S&P is Ba1/BB+/BB+ or below.

Market Update

Market Update for the Month Ending November 30, 2019

A November to be thankful for
November was another positive month for markets, with each of the three major U.S. indices setting all-time highs on the back of trade optimism, encouraging economic updates, and improving fundamentals. The S&P 500 gained 3.63 percent during the month, and the Dow Jones Industrial Average rose by 4.11 percent. The Nasdaq Composite led the way with a 4.64 percent gain for the month. All three indices have now returned more than 20 percent for the year.

These positive results were supported by improving fundamentals. According to Bloomberg Intelligence, with 95 percent of companies reporting, the blended third-quarter earnings for the S&P 500 declined by 1.3 percent year-over-year. This is far better than initial estimates of a 3.6 percent decline. The positive results were widespread, with 9 of 11 sectors beating their initial estimates. Fundamentals ultimately drive performance over the long term, so this result for the third quarter was welcomed by market participants. Technicals were also supportive for markets, with all three indices spending the entire month comfortably above their respective 200-day moving averages.

Results were mixed internationally. The MSCI EAFE Index gained 1.13 percent during the month, but emerging markets did not fare as well. The MSCI Emerging Markets Index declined by 0.13 percent, as slowing growth in India and rising political risks in Latin America caused volatility. Both indices were well supported technically, spending the entire month above their respective trendlines. This marks the second straight month where the emerging market index finished above its 200-day moving average; it last did so in July.

Fixed income had a more challenging month, with rising rates hindering returns. The 10-year Treasury note finished October with a yield of 1.69 percent and rose as high as 1.94 percent in November before ending the month at 1.78 percent. The Bloomberg Barclays U.S. Aggregate Bond Index lost 0.05 percent. High-yield bonds, which are typically less closely tied to movements in interest rates, fared better, with the Bloomberg Barclays U.S. Corporate High Yield Index gaining 0.33 percent.

Solid month for economic updates
November’s economic updates largely came in better than expected, painting a picture of steady economic growth. The month started on a positive note with the October employment report, which showed 128,000 new jobs against expectations for 85,000. This was an impressive result, given the headwinds from the General Motors strike. September’s results were also revised upward. Despite the positive results over the past couple of months, however, the pace of new job creation sits well below levels seen in 2018.

This slowdown in job growth was one of the primary factors that led the Federal Reserve (Fed) to cut interest rates by 25 basis points at its October meeting. This marked the third straight meeting where the Fed cut interest rates in a bid to lower borrowing costs and spur faster economic growth. The rebound in the housing market and solid consumer spending growth provide evidence that the Fed’s actions have begun to positively affect economic growth.

Housing has been a bright spot for the economy over the past few months, as declining mortgage rates have drawn more potential buyers into the market. Existing home sales increased by 1.9 percent in October, marking the fourth straight month of year-over-year growth. New home sales were just as impressive, reaching a post-recession high over the past two months, as shown in Figure 1. Housing was in an extended rut for much of 2018 and early 2019, so the pickup we’ve seen lately is very encouraging, given the importance of the housing market to the overall economy.

Figure 1. New Home Sales, November 2007–Present

chart

The strength in housing sales is encouraging on its own, but consumers were also willing to spend more in general during the month. Personal spending rose by 0.3 percent in October, up from 0.2 percent growth in September and 0.1 percent in August. This marks the eighth straight month of personal spending growth. October’s retail sales also grew by 0.3 percent, rebounding from a disappointing decline in September. This spending acceleration is a good sign for fourth-quarter growth, as consumer spending has been one of the major drivers of overall economic growth during the year.

Speaking of economic growth, the second estimate of third-quarter gross domestic product growth was released in November. This update showed that the economy grew at an annualized rate of 2.1 percent during the quarter, which is up from the initial estimate of 1.9 percent. This result beats the 2 percent growth rate we saw in the second quarter, with personal consumption remaining the major contributor overall.

Confidence improves in October
The better-than-expected results from the month were supported by rising confidence levels. Consumer confidence, as represented by the University of Michigan consumer sentiment survey, improved for the third straight month, after hitting a three-year low in August. Consumer confidence is driven largely by the strength of the job market and equity performance. So it’s not much of a surprise that we’ve seen improving confidence over the past few months, given the recent employment and equity market results.

Business confidence also improved during the month. The Institute for Supply Management composite index, which measures manufacturer and nonmanufacturer confidence, increased to 54 in October after falling to a three-year low of 52.1 in September. This rebound in October helped calm fears of a sudden drop in business confidence that could lead to a decline in business investment.

Both consumer and business confidence have experienced volatility this year, as political uncertainty has negatively affected confidence levels. Going forward, improving confidence would be a tailwind for future growth, as high confidence tends to support faster spending growth and investment.

Political risks remain real yet muted
Despite the positive results we saw for markets and economic updates last month, political risks have the potential to affect markets at any time. There were a handful of potentially important developments over the past month that should be monitored. Domestically, the continuing impeachment proceedings showcase the potential for political instability, even if markets have so far shrugged off any impact from the now-public hearings.

Internationally, risks remain as well. In the U.K., general elections are scheduled for midmonth. This election is set to dramatically affect Brexit negotiations ahead of the January 31 deadline to get a trade deal hashed out with the European Union. No matter who ultimately wins additional seats in Parliament, this election will serve as a potential source of uncertainty.

China continues to deal with riots in Hong Kong. Violence and rhetoric intensified following local elections that saw pro-democracy candidates dramatically outperforming establishment pro-China candidates. The U.S. added uncertainty in the region by passing a bill supporting pro-democracy protestors near month-end, against which China has pledged to retaliate. Given the new developments, the question of Hong Kong’s autonomy will likely play a large role in the ongoing U.S.-China trade negotiations, complicating an already politically complex situation.

As we saw last month, U.S. markets have recently shown themselves to be resilient against headline-related volatility. There is no guarantee this will last, however. These potential areas of concern will be important to monitor going forward, as an unexpected result could very easily cause further volatility.

Economy remains poised for growth
All things considered, economic fundamentals remain positive, and, in many ways, they improved during the month. Current growth levels suggest the economy is on track for a slow and steady year of growth, with the pickup in third-quarter growth showing the resiliency of the current expansion. The combination of improving confidence and continued support from the Fed helped drive additional consumer spending, which was a major driver of growth earlier in the year. The improvements we saw in business confidence could indicate a rebound in business spending is set to follow, which would be a tailwind for additional growth as we finish out the year.

With that being said, very real risks to markets remain. The ongoing uncertainty from political developments, both at home and abroad, has the potential to cause market volatility. Although markets have shown themselves to be largely resilient to headlines, it is quite possible we will experience some market turbulence if there are negative political developments.

Despite the possibility of future volatility, the strong fundamentals should help support markets, as has been the case for most of the year. Whatever short-term turmoil we may encounter, however, a well-diversified portfolio matched to your risk tolerance remains the best way to meet your financial goals over the long term.

Co-authored by Brad McMillan, managing principal, chief investment officer, and Sam Millette, senior investment research analyst, at Commonwealth Financial Network.

All information according to Bloomberg, unless stated otherwise.

Disclosure: Certain sections of this commentary contain forward-looking statements based on our reasonable expectations, estimates, projections, and assumptions. Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict. Past performance is not indicative of future results. Diversification does not assure a profit or protect against loss in declining markets. All indices are unmanaged and investors cannot invest directly into an index. The Dow Jones Industrial Average is a price-weighted average of 30 actively traded blue-chip stocks. The S&P 500 Index is a broad-based measurement of changes in stock market conditions based on the average performance of 500 widely held common stocks. The Nasdaq Composite Index measures the performance of all issues listed in the Nasdaq Stock Market, except for rights, warrants, units, and convertible debentures. The MSCI EAFE Index is a float-adjusted market capitalization index designed to measure developed market equity performance, excluding the U.S. and Canada. The MSCI Emerging Markets Index is a market capitalization-weighted index composed of companies representative of the market structure of 26 emerging market countries in Europe, Latin America, and the Pacific Basin. It excludes closed markets and those shares in otherwise free markets that are not purchasable by foreigners. The Bloomberg Barclays Aggregate Bond Index is an unmanaged market value-weighted index representing securities that are SEC-registered, taxable, and dollar-denominated. It covers the U.S. investment-grade fixed-rate bond market, with index components for a combination of the Bloomberg Barclays government and corporate securities, mortgage-backed pass-through securities, and asset-backed securities. The Bloomberg Barclays U.S. Corporate High Yield Index covers the USD-denominated, non-investment-grade, fixed-rate, taxable corporate bond market. Securities are classified as high-yield if the middle rating of Moody’s, Fitch, and S&P is Ba1/BB+/BB+ or below.

The Independent Market Observer

Commentary from Commonwealth’s Chief Investment Officer

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