Despite all the concerns surrounding COVID-19 (see RGT’s thoughts here) and yesterday’s surprise 50bps reduction in the Fed Funds rate, it’s hard to forget that this year is an election year. We all know what that means: incessant media coverage of candidate personalities and their policy proposals – caricatures and unrealistic talking points, mainly. Many policy proposals, regardless of which side of the aisle they come from, would likely have a direct impact on your investment portfolios: higher capital gains taxes, financial transaction taxes, taxation on unrealized gains, or various regulatory changes. Other policy proposals may have a more indirect, though no less impactful, effect as they consider broader issues that could spur or hinder both domestic and global economic growth.
“If you keep facing in the right direction, all you need to do is keep on walking.” Buddhist saying
At the start of a new decade we are bombarded with a plethora of reviews and “best of” articles for the last ten years. Contemplating the investment results of the last ten years, it’s helpful to look back and remember the environment investors faced at the dawn of the last decade. In the first quarter of 2010 the U.S. economy posted its third consecutive quarter of growth, but the National Bureau of Economic Research had yet to declare the end of the recession. Much of the growth from the previous quarters was attributed to extraordinary government stimulus – remember TARP, TALF, and Cash for Clunkers? The unemployment rate in January 2010 was 9.8%. U.S. government debt outstanding was approaching $13 trillion, the budget deficit was approximately $1.3 trillion, and the House Budget Commission estimated the national debt would grow to $18-$20 trillion by 2020. Interest rates were low, the 6-month T-Bill yielding 0.18%, the 2-year Treasury 1.09%, the 10-year Treasury 3.85% and the 30-year Treasury 4.65%. We were coming off a year where the S&P 500 returned 26.5% but that return was eclipsed by the 79.0% return of the MSCI Emerging Markets Index. Off that stellar performance many market pundits were touting Emerging Market stocks as the growth engine for the coming decade.
Fast forward ten years – the economic expansion that was nascent in early 2010 continued uninterrupted for the next ten years. Unemployment fell all the way to 3.5% by November 2019. While the 2019 federal budget deficit, projected to come in at $984 billion by the Congressional Budget Office, is less than the annual deficit of 2010, the total federal debt is projected to exceed $23 trillion in early 2020 by Truth in Accounting. Interest rates rose on the short end of the yield curve with the 6-month T-Bill rising from 0.18% to 1.60% and the 2-year Treasury up from 1.09% to 1.58%. On the long end of the curve, however, rates fell – the 10-year Treasury from 3.85% to 1.92% and the 30-year Treasury from 4.65% to 2.39%. This “bear flattening” of the yield curve was a boon for investors in longer-dated bonds, but a bust for investors who kept their interest rate exposure short. And it was not Emerging Market stocks that performed best, but large-cap U.S. Stocks as represented by the S&P 500, which returned a cumulative 246.79% for the decade, its only year of negative performance coming in 2018 at -4.38%.
Coming off a dismal end to 2018, investors began 2019 in a cautious mood. But markets have a way of surprising us, and the S&P 500’s return of 31.49% in 2019 was its best return since 2013 (32.39%) and its second-best annual return since 1997. Other major stock indices enjoyed strong returns in 2019 as well, with the Russell 2000 up 25.52% and the MSCI-EAFE Index gaining 22.01%. The outperformance of U.S. stocks relative to foreign stocks (S&P 500 vs. MSCI-EAFE) marked the eighth time in the last ten years the S&P 500 had larger gains than the MSCI-EAFE. But investors would do well to remember that in the ten years before that (2000-2009) the MSCI-EAFE outperformed the S&P 500 in seven of those ten years.
Bond markets also enjoyed a strong 2019, the broad Bloomberg Barclays U.S. Aggregate Index up over 8% and the Bloomberg Barclays Municipal Bond 5-Year Index up over 5%. Much of the returns in bonds was driven by a decline in interest rates. The 10-year U.S. Treasury opened the year yielding 2.66% and finished the year with a yield of 1.92%. The 2-year Treasury yield fell from 2.50% to 1.58% and the 30-year Treasury fell from 2.97% to 2.39%. And thus, the last year of the decade was somewhat emblematic of the decade, starting off with trepidation yet ending the year with stronger-than-expected performance for both stocks and bonds.
Hopefully this little walk down memory lane highlights how difficult it is to imagine how the next ten years might play out. Making the right 10-year predictions based on one’s assessment of the current market environment is an exceedingly difficult task. Developing the appropriate strategic investment plan, though, at least gets you facing in the right direction. The trick is to stay disciplined, to “keep on walking,” despite the temptations to stop and change course based on the emotions of the moment.