Letter to Clients: First Quarter 2020

January 2020

Dear Clients and Friends:

We hope everyone had a wonderful holiday season. Whether you reached your personal goals last year, faced challenges, or are looking for a 2020 reboot, a new year and a new decade bring both new challenges and new opportunities.

2019 – Market Year in Review

Before 2019 began, stocks were in the midst of a steep sell-off, which shaved nearly 20% off the S&P 500 index over the final quarter of 2018. At the time, the Fed was on rate-hike autopilot gradually increasing the fed funds rate in quarter-point increments. In addition, the Fed was allowing bonds purchased during its bond buys (popularly called QE or quantitative easing) earlier in the decade to run off its balance sheet.

The rate hikes, which began in late 2015, did little to deter bullish enthusiasm. That is, until October 2018 when investors began to fret that the Fed might be on the verge of a policy mistake that could tip the U.S. economy into a recession. Paired with rising trade tensions with China, a steep and unsettling correction ensued which rivaled the 2011 sell-off which was tied to recession fears and a widening eurozone debt crisis. For those who keep such statistics, a loss of just seven more points on the S&P 500 Index would have officially ended the bull market, which began in 2009.

2018 ended amidst classic investor overreaction. Emotions can dictate actions of short-term traders and computer-based trading programs can influence sentiment and exacerbate market moves. Sometimes excess euphoria breeds too much enthusiasm and stocks become temporarily overvalued. By December 31, 2018 the opposite had occurred. Pessimism ruled Wall Street and stocks were undervalued while economic growth was poised to moderate but not stall. Profit growth slowed but an earnings recession did not ensue.

In 2019 trade headlines and Fed policy had the biggest influences on sentiment. Market action marched to the beat of trade. Positive trade headlines generated enthusiasm and tensions created pullbacks. In May and August rising tensions forced the bulls to the sidelines. Still, the broad-based S&P 500 Index lost less than 7% during each of the pullbacks[i]; modest by historical standards. We believe the Fed’s flexibility and continued economic growth cushioned the downside.

Last year we also saw a shift in policy at the central bank. In January, the Fed abandoned its desire to keep bumping up the fed funds rate. Instead of two projected rate hikes in 2019 projected by the FOMC in December 2018, the Fed eased and cut rates three times. The year began with a fed funds rate of 2.25%-2.50% and ended with a rate of 1.50%-1.75%. It was a dramatic about-face that was dictated by a changing economic environment.

Additionally, the Fed stopped shrinking its balance sheet. By year end the Fed was back in the open market purchasing shorter term bonds and T-bills, at least temporarily. While it refuses to use the term “QE”, in effect, it’s employing a similar policy to what it used earlier in the last decade.

In December, Fed Chief Jerome Powell hinted that he is in no hurry to take back any of the rate cuts in 2020.

Recession fears have subsided, and the U.S. and China are expected to sign a limited, phase-one trade deal this month. It’s not the all-encompassing agreement that investors had hoped would be inked earlier last year, but it reduces near-term trade tensions. New negotiations, which could eventually lead to a more comprehensive phase-two agreement, will resume though the outlook for additional progress is murky.

Stocks finished out 2019 in an impressive fashion.

Longevity – One for the Books

The current economic expansion began in July 2009, according to the National Bureau of Economic Research (NBER), the official arbiter of recessions and expansions. Ten years later the economic expansion entered the record books, surpassing the long-running expansion of the 1990s. Following the financial crisis and Great Recession, few thought the expansion would last this long. Few thought we’d ever see the jobless rate fall below 4% again. Once again, the U.S. economy has been surprisingly resilient.

That said, should we really be surprised? The U.S. economy is incredibly dynamic. The attributes that make America the greatest nation in the world continue to pay economic dividends. Once again, the economy bounced back when many thought it was down for the count.

That leads us to the next question, and one of a shorter-term nature. Might a recession be lurking in 2020? A recent survey noted, “For U.S. CEOs, a recession rose from being their third biggest concern in 2019 to their top one in 2020.”[ii] Global growth slowed last year and activity in the U.S. manufacturing sector has been soft. A recession is inevitable, but is 2020 the year?

Historically, economists haven’t done a very good job of forecasting recessions, but conditions that generally lead to a recession aren’t in place today. These include:

  1. Rising interest rates and rising inflation.
  2. A credit squeeze that cuts off lending to businesses and consumers.
  3. Asset bubbles. Stocks aren’t cheap, which make them vulnerable to unexpected events, but valuations (P/E ratios) are nowhere near year levels seen in 2000.
  4. Oil supply shock.

In addition, the long-running expansion has been subpar. That means we haven’t seen the excesses and imbalances that breed too much euphoria and excess spending.

While manufacturing has been soft and the Conference Board’s Leading Index isn’t suggesting a near-term acceleration in growth, the broader-based service sector is expanding, and consumer spending has been strong. Furthermore, stock market action isn’t foreshadowing a near-term recession.

Playing the Averages

Flip a coin and there is a 50-50 chance it will come up heads. Walk into a casino and put money on the table, the odds are stacked against you. On the other hand, if you simply purchase a broad-based, diversified stock market portfolio at the beginning of the year, historically, the odds have been in your favor.

Of course, we do not recommend all-stock portfolios because there is too much risk of short-term volatility. Equities are also typically weak income producers, which may be more important than capital appreciation for many investors. Our recommendations are customized to your goals and preferences.

If we look back at the data over the last 60 years, stocks have been an excellent vehicle for individual investors to create wealth. The S&P 500 Index has risen 47 years and has fallen 13 years (total return, dividends reinvested 1960-2019)[iii]. That is an impressive performance that covers periods of both rising and falling inflation, rising and falling interest rates, wars and peacetime, and several expansions and recessions.

However, returns have varied by a wide margin. When the S&P 500 Index finished the year lower, the average annual decline has been -12.7%. The range of the annual decline varies from -3.1% to -36.6%. When the S&P 500 Index finished higher, the average annual increase has been an impressive 18.0%. The range of the annual increase varies from +0.3% to +37.2%.

Stocks have a long-term upward bias. It’s a theme we often repeat, and the data continues to support. We view a well-diversified portfolio as the economic equivalent of purchasing a stake in the U.S. economy. We don’t know for certain if the economy will be larger next year (we believe it will), but over a long period of the time the U.S. economy has always expanded. We see it reflected in long-term stock market performance.

Table 1: Key Index Returns

Dow Jones Industrial Average 22.3
NASDAQ Composite 35.2
S&P 500 Index 28.9
Russell 2000 Index 23.7
MSCI World ex-USA* 19.0
MSCI Emerging Markets* 15.5
US Aggregate Bond TR** 8.7
Source: Wall Street Journal, MSCI.com, Morningstar

YTD returns: Dec 31, 2018 - Dec 31, 2019                    *in US dollars **Bloomberg Barclays

Final thoughts

There will be times when the outlook sours, but as we’ve seen time and time again, the U.S. economy has recovered and gone on to new highs. We know stocks can be unpredictable over a short time period. While they are sometimes unpleasant, sell-offs are normal. At DV Financial, we take precautions to minimize volatility and keep you on track toward your financial goals.

As we move into the new decade, it is a good time to be reminded of a remark by the legendary investor Warren Buffett, “For 240 years it’s been a terrible mistake to bet against America, and now is no time to start. America’s golden goose of commerce and innovation will continue to lay more and larger eggs.”[iv]

We are here to assist you. Please feel free to reach out to us by email or call (515) 255-3354; you can also like and follow us on Facebook @dvfin. We especially enjoy when you share our value with others and consider it the highest form of complement. If you know of others who seek answers to calm their financial nerves, we would appreciate the introduction.

As always, we are honored and humbled that you have given us the opportunity to serve as your financial advisor. As 2020 gets underway, I want to wish you and your loved ones a happy and prosperous new year!


Art Dinkin, CFP®

This newsletter contains general information that may not be suitable for everyone. The information contained herein should not be construed as personalized investment advice. Past performance is no guarantee of future results. There is no guarantee that the views and opinions expressed in this newsletter will come to pass. Investing in the stock market involves gains and losses and may not be suitable for all investors. Information presented herein is subject to change without notice and should not be considered as a solicitation to buy or sell any security.

Indices are unmanaged and investors cannot invest directly in an index. Unless otherwise noted, performance of indices do not account for any fees, commissions or other expenses that would be incurred. Returns do not include reinvested dividends.

The Dow Jones Industrial Average (DJIA) is a price-weighted average of 30 actively traded “blue chip” stocks, primarily industrials, but includes financials and other service-oriented companies. The components, which change from time to time, represent between 15% and 20% of the market value of NYSE stocks.

The Nasdaq Composite Index is a market-capitalization weighted index of the more than 3,000 common equities listed on the Nasdaq stock exchange. The types of securities in the index include American depositary receipts, common stocks, real estate investment trusts (REITs) and tracking stocks. The index includes all Nasdaq listed stocks that are not derivatives, preferred shares, funds, exchange-traded funds (ETFs) or debentures.

The Standard & Poor's 500 (S&P 500) is an unmanaged group of securities considered to be representative of the stock market in general. It is a market value weighted index with each stock's weight in the index proportionate to its market value.

The Russell 2000 Index is an unmanaged index that measures the performance of the small-cap segment of the U.S. equity universe.

The MSCI All Country World Index ex USA Investable Market Index (IMI) captures large, mid and small cap representation across 22 of 23 Developed Markets (DM) countries (excluding the United States) and 23 Emerging Markets (EM) countries*. With 6,062 constituents, the index covers approximately 99% of the global equity opportunity set outside the US.

The MSCI Emerging Markets Index is a float-adjusted market capitalization index that consists of indices in 21 emerging economies: Brazil, Chile, China, Colombia, Czech Republic, Egypt, Hungary, India, Indonesia, Korea, Malaysia, Mexico, Morocco, Peru, Philippines, Poland, Russia, South Africa, Taiwan, Thailand, and Turkey.

Barclays Aggregate Bond Index includes U.S. government, corporate, and mortgage-backed securities with maturities of at least one year.

[i] St. Louis Federal Reserve S&P500 Data

[ii] The Conference Board, Survey: Buisiness Leaders Start 2020 with Lingering Concens about Talent Shortages & Recession Risk

[iii] New York University, Stern School of Business

[iv] https://www.nytimes.com/2016/02/28/business/dealbook/buffett-in-annual-letter-rejects-candidates-message-of-us-decline.html