Stock markets are riding high as we approach the end of 2019. The S&P 500 has returned nearly 30% with dividends, the MSCI EAFE index of developed markets is up over 21%, and the MSCI Emerging Markets index has gained about 15%. What's more, the largest pullback in the S&P 500 this year was only 7%. There are three key reasons for this outsized performance, and one important takeaway for investors as we enter 2020.
Perhaps the most important reason that major markets have experienced double-digit returns is that the economy is still growing at a healthy pace. Not only has the recession that many investors feared only a year ago not materialized, but very few economists now expect a recession in the near future. The unemployment rate has continued to fall to 50-year lows and consumer net worth is at record highs. And yet, with inflation at around 2% or less, there are no signs of the economy overheating just yet.
Not everything is rosy - corporate investment is lackluster which may hurt future productivity. Additionally, the manufacturing sector is effectively in recession with most indicators suggesting that output is shrinking. Of course, some of this effect is tied to the U.S.-China trade dispute which may improve over time. Still, these factors have not dissuaded many investors that the U.S. economy can experience real GDP growth of 2% per year.
Another important reason for this year's gains is that central banks are still pouring stimulus into the system. The Fed made a full U-turn from hiking rates last December to lowering rates in July. They've cut rates three times and are signaling that they are on pause for the foreseeable future. Their latest Statement of Economic Projections from last week show that they expect rates to be flat until 2021 at the earliest (the second chart below).
Finally, there is a technicality in the market return numbers. Since 2018 ended near the market lows during an almost 20% stock market pullback, a significant part of this year's return was simply returning to previous levels. From last year's market peak to today, the S&P 500 has gained about 11% with dividends. While this is a terrific return, it's not the number that will be advertised in headlines.
It's clear that macro-economic drivers have played a large part in market returns in 2019. The most important takeaway for investors, however, is that these factors may be of less help in 2020. The global economy would have to accelerate, and the Fed would need lower interest rates further, in order to excite investors. So, while the stats this year are outstanding, investors should have healthy expectations for their portfolios going forward.