Q4 2019 Market Commentary

Director of Investments Todd Jones, MBA, CAIA®, weighs in on the current financial environment, critical market trends to watch, and what it all means going forward.

Here’s what Todd is talking about this quarter:

  • Looking back on 2019

  • The 2020 US elections

  • Central bank activism is here to stay

  • Our area of focus for 2020

2019 closed out the year in rockstar fashion; with a bang. 

After an abysmal asset class showing in 2018, 2019 performance appears to be just the inverse with nearly all major asset classes we track posting a positive return.  To be sure, our Investment Strategy Group (ISG) was surprised by the magnitude of the move higher across markets; particularly in equities.  While we were correct in identifying a continuation of the current economic cycle, we did not expect the massive change in investor sentiment.  This sentiment shift can be observed in the change in the S&P 500 forward P/E ratio[1] which expanded from 14.5x on January 1st, 2019 to 18.8x on January 1st, 2020[2].  Four percentage points may not seem like a significant change, however, there is no arguing with math:  4.3/14.4 = 29.6% change.  Add in ~2% in a dividend yield and ~0% in earnings growth for the S&P 500 and you’ve roughly calculated the return for US equities for 2019.  While we welcome the positive performance, it would be lazy to count on continued multiple expansion in equities from this point forward.  Thus, in our base case scenario for 2020, we expect more modest returns across US equity indexes, reflecting a mid-to-high single-digit earnings growth driven primarily by a cessation of the global trade war.  We remain overweight US equities.  Developed international equities are approaching fair value while select emerging market equities appear more attractive (Brazil, India) due to unique growth dynamics as well as the potential for declining real interest rates[3].  Admittedly, emerging markets equities have dramatically underperformed US stocks over the last 10 years.  Yet, we also recognize that past performance is a poor indicator of future returns.  (Price performance for the S&P 500, MSCI EAFE, and MSCI EM indexes[4] are referenced in the chart below and does not include dividends.)  A series of positive factors (the most important of which would be a declining US Dollar) are turning the attention of our ISG to emerging market equity positions given our relatively low exposure and potential for low correlation with developed markets.

Our modestly constructive positioning may lead to the observation that by maintaining our equity exposure, aren’t we taking on excessive risk near all-time highs?  The simple fact is, while it’s never comfortable committing capital at all-time highs to the equity market, history would suggest it’s not a bad idea. 

After breaking through the previous highs from 2007, the S&P 500 has made new highs (noted in red arrows) in almost every year since 2013.  A certain point level on the S&P 500 is not enough to cause our Investment Strategy Group (ISG) to recommend reducing equity exposure as we are value-oriented.  There has to be more to the story than just a high index level to raise alarm.  In our assessment, we see a global economic backdrop that has the potential to marginally improve in 2020, not weaken.

2020 US Elections

The 2020 US elections are one of those events that have the potential to create divergent outcomes in the equity markets this coming November (so it’s worth mentioning).  While we normally don’t like to opine on the political aspects of investing, client interest in the subject currently dictates a brief commentary.  What follows are our best estimates of probability and outcome to the three most-likely scenarios relating to the 2020 US Presidential election.

  • The most likely outcome (>50% in our estimation based on prediction markets)[1] is that President Trump wins a second term assuming the articles of impeachment don’t result in a conviction in the US Senate.  This is also likely the consensus view as President Trump has been viewed by the equity markets in a positive light and allow the S&P 500 to achieve a relatively muted mid-high single-digit return.

  • A less likely scenario (20-30% probability) would be a Presidential win by centrist Democrat Joe Biden. Biden doesn’t bring a mandate for significant policy change at present and is running a campaign of restoring dignity to the office of the President.  In this scenario, it’s likely the S&P 500 would experience a shallow decline <10% until a concrete agenda surfaces.


  • The third and least likely outcome (<20% chance), would be a win by one of the further-left candidates (either Bernie Sanders or Elizabeth Warren) bringing with them a mandate for change. This outcome would likely pressure the relatively high P/E multiple of the S&P 500, sending equity markets down (at least temporarily) to the tune of -20% or more.

Having outlined the probabilities of each occurrence and their potential outcome, we wanted to highlight that the outcomes are not extreme in our assessment (+8% to -20%).  Certainly a -20% is nothing to minimize, however that number is not catastrophic for a vast majority of our financial plans.  This has to do with the fact that most of our client portfolios owns a diversified mix of not only stocks, but also bonds, alternatives, and private investments.  Further, we believe we have constructed portfolios in such a way that a drawdown in the equity portion of a portfolio will be mitigated with contributing returns from the other areas mentioned above.  All this is to say, while the rhetoric of the political cycle is likely to get more heated as we get closer to November, the outcome of the US Presidential election will likely be priced into markets well in advance.

Meet the New Boss, Same as the Old Boss

After another exceptional year in most financial markets, many clients are asking how much longer the rally in stocks (as well as bonds) can last.  Frankly, the answer was much clearer in January of 2019 as most global equity markets had just suffered a ~20% decline in the prior month.  As we indicated in our Q4 2018 Market Commentary (found here), we believed that January 2019 was a good time to add to equity exposure given the lower prices and more reasonable valuation.  Fast forward to today, the picture is cloudy with elevated stock and bond valuations in US markets, average stock valuations internationally, and exceptionally elevated international bond valuations.  How did we get here?

There were many developments in 2019 that contributed to easing investor anxiety.  We would contend that actions from the world’s central banks had an outsized, calming effect.  Not only did the European Central Bank (ECB) and Bank of Japan (BOJ) continue in their quantitative easing programs, the US Federal Reserve aided the situation by not only reducing short term interest rates twice (via the Federal Funds Rate) but also restarting its previously discontinued quantitative easing program in support of the inter-bank repurchase market (otherwise known as REPO).  All this is to say, in our mind, the defining characteristic of 2019 in financial markets was that the world’s central banks were all very stimulative and, most importantly, coordinated.  As the chart below would suggest, post Great Financial Crisis, global central banks have a Pavlovian response to weakening global growth.

Looking forward, we believe that central bank activism is here to stay in one form or another.  The accommodative policies of the world’s central banks should help keep fixed income markets tame, and by extension, equity markets generally positive.  The US Federal Reserve, in particular, appears very attuned to dislocations in both the credit market as well as the equity markets.

Our Areas of Focus for 2020

As we enter the new year, our priorities have not evolved too dramatically from those we presented in 2019.  We remain committed to our asset allocation targets across asset classes.  While we can, and have on occasion, adjusted the weighting between stocks, bonds, alternatives and cash equivalents, we currently have no strong reason to change course.  We continue to believe that increasing cash levels and periodic rebalancing plays an important role in managing risk.  Current equity market conditions are presenting an opportunity to rebalance.  We are also spending a significant amount of time trying to identify where the consensus may be wrong.  As best we can observe, the primary area where our views diverge from the consensus is in inflation.  You may recall that we’ve recently added a commodities position to select strategies in an effort to hedge, what we believe to be, are rising inflation risks.  Finally, as public markets move higher from here, we continue to recommend portfolios adopt increasing exposure to private investments.  Historically, limited liquidity has been a reason to disqualify private investments from significant allocation in our portfolios.  However, with both bond and stock valuations nearing all-time richness, we think now may be an opportune time to convert a portion of liquid investments into private markets.  We look forward to the opportunities that lie ahead.

Authored by:

Todd Jones, MBA, CAIA®

Director of Investments
Investment Strategy


Gratus Capital is an SEC-registered investment adviser. Registration with the SEC does not imply any level of skill or training. Our ADV documents are available upon request. The opinions expressed are as of January 2020 and may change as economic conditions vary. The information provided is not intended to be relied upon as specific investment advice and is not a recommendation, offer or solicitation to buy or sell any securities. Examples provided are based on current market conditions, and there is no guarantee that any applicable condition will remain in place. Portfolio holdings are subject to change at any time and may differ materially in the future from case studies presented. No graph or chart by itself can be used to determine which securities to buy or sell or when to buy or sell them. As with any investments, past performance is not a guarantee of future results. There is no guarantee that any investment strategy will achieve its objectives, generate profits or avoid losses.

[1] P/E ratio is a numerical value calculated by dividing a stock or index price by its earnings.  This ratio is one of the better-known indicators to help investors assess whether a stock or index is overpriced or underpriced relative to its long term average.
[2] Goldman Sachs research estimate published December 31, 2019
[3] Real interest rates takes the nominal yield on a bond and subtracts the current inflation rate.  What residual number remains is known as the real rate.
[4] MSCI EAFE stands for the Morgan Stanley Europe, Australia and Far East index.  MSCI EM stands for the Morgan Stanley Emerging Markets index.
[5] https://www.predictit.org/markets/detail/3698/Who-will-win-the-2020-US-presidential-election