Market Report – Winter 2020

The U.S. stock market closed the year with significant gains. Large company stocks in the U.S. were up 31.5%, small company stocks rose 25.5%, and bonds returned 8.7%. Foreign stocks were also up, rising by 22%.

When we entered 2019, the stock market had just endured steep losses in December 2018, the worst December for stocks since the Great Depression. The markets rebounded swiftly and forcefully in the first quarter of 2019, contributing to a good year for stocks.

Throughout the year, however, the market see-sawed back and forth in response to the trade war, with positive news generally nudging the stock market higher and negative news pulling it lower. The combination of Fed rate cuts and hopes for a resolution to trade tensions were enough to overcome doubts among investors, and boost stocks. By year’s end, a tentative initial deal had been announced that served to relieve anxious investors.

The Federal Reserve Open Market Committee (the Fed) cut interest rates three times in 2019 in an effort to spur growth in the domestic economy. The stock and bond markets, as well as the economy overall, often respond well to declining interest rates, which can stimulate economic growth – whether necessary or not. The Fed was responding to data showing a slowing global economy, which was either aggravated by or caused by the ongoing trade war with China. The ebbing effects of the November 2017 tax cut in the U.S. have also contributed to economic slowing.

Proponents of the 2017 tax cuts admitted that reducing corporate tax rates from 35% to 21% would add to the federal deficit (the annual shortfall between federal revenues and expenditures) but assured us that lowered taxes would generate such growth in corporate profits that new tax revenues on those profits would more than offset the loss, thereby actually reducing deficits. This involved a noteworthy amount of optimism because, as calculated by Forbes magazine, breaking even on those lost tax revenues would have required a 67% increase in overall corporate profits. As expected, the federal budget deficit increased in 2018 by some $113 Billion, or 17%. The deficit for 2019 is projected to increase by an additional 26%.

Progress at the Madrid U.N. Climate Summit in December was nowhere near satisfactory, underscoring the necessity for climate action by sustainable investors. In addition to the moral imperative to fight climate change, companies that ignore climate risks are becoming high-risk investments themselves, due to the business perils of their inaction. Therefore, investors need reliable methods to evaluate the climate risks inherent in every public company. John Wilson of Calvert Funds (held in many Natural Investments client accounts) testified on Capitol Hill in October on the idea of establishing a carbon tax: “A carbon tax or similar policy signal could allow investors to better quantify the economic implications of climate change on investments and more efficiently allocate capital to investments suitable for the low-carbon economy.” We’re in agreement.

Looking forward, economists are warning that even without a recession, U.S. stock and bond returns may be lower in 2020. Starting points matter; as the U.S. stock market finished 2019 at near-record levels, and bonds produced above-average returns for the year as well, this will be harder to repeat in 2020––especially with few or no Fed rate cuts, as may be the case. The average return for large company U.S. stocks over the last ten years has been about 13%, approximately 30% above long-term averages. Should stocks “revert to the mean” over the coming decade, stock market returns could fall below their 10% long-term average.

Scott Secrest

Scott Secrest

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