Alexis de Tocqueville
First, there was the East Asian Financial Crisis of 1997. In 1998 there was the Russian debt default and the collapse of Long Term Capital Management. In 1999 there were fears of the “Y2K bug” and the possible collapse of the global technological infrastructure’s ability to process payments for years starting with the number 2. The Federal Reserve responded by lowering interest rates and injecting liquidity into the financial system. The United States experienced a corporate recession but the economy remained robust with strong consumer spending. The financial markets, delighting in the intoxicating elixir of a dovish fed and continued economic growth responded by bidding up the NASDAQ index a cool 100% in 1999.
The past several years have offered up Brexit, “tariff wars” between the US and China and global economic growth rates that post the Global Financial Crisis of 2007-2009 are only 60% of those of the 1990s. Between the 4th quarter of 2017 and the 2nd quarter of 2019, the US economy grew 2.9% or more five out of seven quarters. In the face of seemingly increasingly robust rates of economic growth, the Federal Reserve increased interest rates three times in 2017 and four times in 2018. Looming over the horizon in early 2018 however, was that the Federal Reserve was raising interest rates in the face of falling global economic growth rates. The S&P 500 protested by declining by nearly 20% in the 4th quarter of 2018. In 2019 the Federal Reserve reduced interest rates three times and the S&P 500 registered its approval of a Fed that had morphed from Hawk to Dove by rising 28.9%.
In the face of such strong performance numbers for US equities in 2019 investors are left asking themselves what the financial markets could possibly deliver by way of an encore. Do we continue to dance with the partner with which we enjoyed dancing so much with in the past year, change partners or prepare to sit this one out?
Let us hazard a few predictions about the year ahead. Global growth rates accelerate with the growth rates between the US and foreign economies narrowing. The ten-year bull market in the US dollar ends. Global inflation rates increase modestly resulting in an increase in intermediate to longer-term interest rates while central banks hold short term rates at current levels leading to a steepening of the yield curve.
Post Global Financial Crisis equity markets outside of the United States have returned 124% or one-third the 378% return of US equity markets. Actually foreign markets have returned 45% more for local investors but the increase in the value of the US dollar has reduced the return of foreign equities for US investors. Currency markets tend to trade in eight to ten-year cycles with the US dollar advancing 54% from 1993 to 2002 and declining 41% from 2002 to 2008.
In addition to the currency effect, the returns of foreign developed markets are significantly impacted by the notable differences in the composition of their market sectors. Technology is 34% of the US market but only 12% of foreign developed markets. Other significant variances are industrials (7% vs 12%) commodities (7% vs 12%) and financials (13% vs 19%).
There is value in the equity market but you may want to be certain your passport is up to date. Value, married to a notable shift in the global economy and the end of the bull market in the US dollar, might offer investors profits comparable to those of last year but not in the same places.
Mark H. Tekamp
January 29, 2020
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