What an amazing unexpected year of performance in 2019! Was the 2018 Tax Cut and Jobs Act a gift which kept giving in 2019? While that may be a difficult question to quantify, we are clearly seeing the powerful tailwinds of low interest rates, low inflation, accommodative monetary policy, and sustained GDP growth. Since 2017, GDP growth has averaged +2.6% versus +2.2% for an extended period before that time. January marked the 128th month of growth and economic recovery, thus making it the longest recovery in the U.S. economy in history.
Productivity and consumer spending are being impacted by the “app economy” in ways our traditional metrics don’t seem to accurately forecast; yet we see sustained quarter over quarter corporate earnings growth in the U.S. The economic burden of excessive regulatory requirements has been a primary policy objective of the current administration (“cut two regulations for every new one”) and three years of regulatory reform has played an important role in helping sustain US economic growth.
If we survey the macroeconomic landscape, the following key observations are worth noting:
- No sign of economic recession any time soon
- U.S. economy is adapting to lower tax rates
- Monetary policy remains loose
- Home construction appears to lag increasing demand
- Banks are well capitalized
- Inflation remains tame and below Federal Reserve targets
- Global trade friction is dissipating
Some macro economists are posing the question of whether we are entering the end of the classic “boom and bust” economic cycle given the breadth of central bank tools being applied in today’s economy. An interesting question. Certainly, one main conclusion that can be derived from a filter of key macroeconomic metrics is that U.S. entrepreneurship and supportive fiscal and monetary policies will extend the longest economic recovery in U.S. history even further.
How does one handicap the economic impact of a potential global pandemic related to the coronavirus? What do the Monte Carlo simulations of a coronavirus flu pandemic show in the “left tail” of the distribution of forecasted deaths? A scientist at Johns Hopkins Medical Center ran a theoretical simulation of a coronavirus pandemic which resulted in millions of deaths, an 11% decline in global GDP, and a 20% – 40% drop in global equity markets. Therefore, one can construct a scenario in which markets experience significant drawdown in 2020.
While it is likely too early to give credence to this magnitude of concern, there is the very real CASSIA CAPITAL PARTNERS LLC VOL. 22 potential for the coronavirus to impact Asian economies leading to a material softening of global growth. This, coupled with uncertainty of a presidential election year and heightened tensions across the Middle East, can lead to a dramatic increase in market volatility in the current year.
However, one should not attempt to allocate assets based on news headlines or to time the market due to market fear.
A conclusion to be drawn is that volatility should be expected to re-enter the markets for an extended period. Political headline risk will represent an increasing source of potential market uncertainty as the political calendar plays out and various polls are reported in the press. The market is now discounting a likely Fed rate cut rather than an extended pause or tightening. Therefore, the sources for market surprises appear plentiful during the coming year.
We continue to measure the expected level of volatility in our asset allocations, keeping a careful assessment of our models’ standard deviation of return, beta, and upside/downside capture. The macroeconomic landscape appears quite supportive for thoughtful, diversified investment strategies designed to navigate periodic bouts of volatility without derailing sound stewardship in support of longer-term financial goals.