As we meet with our clients, and with colleagues in the professional community, in the first few weeks of 2020, we’re often asked about our expectations for investment returns for the coming year. Now, you might think it would be easy for a professional investment advisor to give a prediction and support it with some compelling evidence. Well, unfortunately it’s really not that easy at all.
What can we say with some level of certainty? The place to start is to assess the general investment environment.
Interest rates are low. The 10-year Treasury Note is yielding 1.5%. That’s very, very low in historical terms. The Federal Reserve reduced short-term interest rates three times in 2019. Federal Reserve Board members are generally reluctant to take any action that might influence a presidential election, so it’s reasonable to assume there won’t be any action until after November. So, we should expect short-term rates to stay pretty much where they are this year.
Unemployment is at a 50-year low. The December jobs report from the Labor Department indicated an unemployment rate of 3.5%. This means the economy is pretty close to full employment. That’s good for workers and for the economy overall.
After languishing for decades, real wages are finally beginning to pick up. That’s good, because workers are consumers. More money in their pockets means they can spend more (and hopefully save more for retirement).
Inflation is still low. The Federal Reserve has been attempting to increase inflation a bit for several years. The economy needs a certain amount of inflation, because businesses are healthy when they can increase their prices and their profits. When prices are stagnant (or worse, declining), consumers will wait to make purchases and this slows the economy. The core inflation rate (which excludes food and energy) in 2019 was 2.3%. The rate was higher for fuel and health care. Overall, the Fed is probably feeling pretty good that prices are rising at a moderate rate.
On the international trade front, the Trump administration finalized the USMCA agreement with our neighbors in Mexico and Canada, and a “phase one” agreement with China. The administration will soon be negotiating deals with the European Union, and with the United Kingdom now that Britain has left the EU. The trade tension that caused markets to gyrate much of last year seems to have dissipated.
US companies, at least those unaffected by the trade wars, have posted solid profits for several quarters running. We will begin seeing fourth quarter numbers soon and most analysts expect them to be solid.
So, the US stock market seems pretty well-positioned to extend its longest bull run in history. While it isn’t realistic to expect returns to be as high as they were last year, many market analysts feel returns will be in the mid single digits.
You might be asking, what could go wrong? Right now, the obvious big threat is the coronavirus that, as we write this, has been declared a public health emergency by the World Health Organization. While the virus has so far infected and killed far fewer than the annual seasonal flu, it has spurred a global response that is beginning to affect the world economy. The US stock market is very clearly reacting to the news associated with the outbreak and this will continue until the situation is under control.
There are other threats for investors, of course. The US could enter an armed conflict with Iran. North Korea could engage in more disturbing saber-rattling. Russia could continue is expansionary ambitions. The massive US national debt ($22 trillion and currently growing at $1 trillion per year) could finally panic investors. Climate change could produce even larger national disasters that damage the economy and spook investors.
The overall investment environment looks reasonably compelling for 2020. We expect bonds to earn 2-3%. We expect US stocks to earn 5-6%. But we do so with great humility, realizing that markets can change very rapidly.
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