December 2019

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Happy New Year!  Our 11th Annual Investment Symposium will be on Thursday, February 27, 2020 at the Westin in downtown Chattanooga.  More details will follow soon, but please save the date as we hope to see you there!

Record setting stock market performance characterized the final year of the decade.  The S&P 500’s rally in 2019 reflected, in part, recovery from a sharp correction in December 2018.  The market surged in the fourth quarter as trade tensions subsided and global economic data improved.  After beginning the year above 2.7%, the 10-year Treasury yield fell to 1.4% mid-year because of deflation scares before settling above 1.9% by year end.  Both the stock and bond markets responded to a shift in policy by the Federal Reserve, which resulted in three 0.25% rate cuts in the second half of 2019.  Of note, the combined performance of stock and bond markets in 2019 was the best since 1998.

While the Fed spent 2018 raising rates and shrinking its balance sheet, the sharp reversal on Christmas Eve 2018 to a more accommodative policy posture represented acquiescence to political pressure, according to many commentators.  Fed Chair Powell argued the policy shift was a necessary “mid cycle” adjustment because of uncertainties associated with the trade war and worrisome economic data, particularly as related to global manufacturing.  Concurrent with the low in bond yields, the Treasury yield curve, as measured by the difference in yield between 2- and 10-year Notes, slipped into negative territory in August 2019.  This prompted widespread fears of imminent recession and calls for aggressive monetary accommodation.  Responding to the Fed’s rate cuts, the stock market fully recovered from the December 2018 correction by late summer, and further gains through the end of the year were fueled by progress in trade negotiations.

We look forward to a new year and a new decade with optimism.  To the extent the Fed has adroitly navigated the economy through the purported “mid cycle” slowdown, further gains in the stock market could prove substantial.  In addition, we expect the Fed will be more tolerant of inflation going forward.   As a barometer for success in this regard, we view the yield on the 10-year Treasury as the principal indicator.  If yields revisit levels below 1.5%, it is likely that global deflationary pressures have overwhelmed the Fed’s liquidity support.  If, however, yields rise above 2.0%, it would suggest sustainable global growth that should be reflected in corporate earnings.  A rise above 3.0% could indicate accelerating inflation and would likely prompt the Fed to be less accommodative.

Across the pond, we now know that England’s separation from the European Union, a process known as “Brexit”, arrives without any further delay at the end of this month.  However, that is not the end of the story.  The United Kingdom faces a deadline of December 31, 2020 to secure new trade arrangements with the EU.  To the extent the next 12 months prove unproductive in that regard, market participants will revisit the prospects of a “hard Brexit” later this year.  A lack of progress in these negotiations could prove a source of significant market volatility as the deadline draws near.  In the final analysis, we anticipate there will be some economic disruption as this process heads to conclusion.  The extent of the market disruption will depend on whether Brexit proves to be a “Y2K-like” non-event or a much more chaotic separation.  Most likely, the economic impact of Brexit will fall somewhere in the middle, but the political, cultural, and historical reverberations will be felt for generations.

Recent developments with Iran are an important reminder that geo-political uncertainties can surface without much warning.  We recommend remaining vigilant, but investors should avoid reacting too quickly to predictions of worse case outcomes.  A well diversified portfolio should provide ballast against heightened volatility if the situation intensifies.