by Connor Darrell CFA, Assistant Vice President – Head of Investments
U.S. equities generated gains for the second consecutive week as investors seemed to grow more confident in efforts to keep the novel coronavirus contained. International equities retreated on Thursday and Friday however after a significant surge in the number of confirmed cases of the disease. The surge in confirmed cases followed a diagnostic reclassification by Chinese authorities, which led to an overnight increase of about 15,000 cases. Markets seemed to interpret the diagnostic change more as a byproduct of shortages in available testing kits than as an issue with the integrity of reporting (which has been a concern for some as a result of China’s questionable handling of the SARs epidemic in 2003).

For now, we see no reason to adjust our already elevated assessment of geopolitical risks (see this week’s Heat Map for more details). The World Health Organization suggested late last week that cases of the virus outside of China’s Hubei Province (the epicenter of the outbreak) were levelling off, which seemed to help contribute to the market’s muted response to the overnight rise in confirmed diagnoses. The greatest risk to the global economy at this time remains supply chain disruptions, which are likely to continue until after cases of the virus have peaked. Manufacturing within China has taken a significant hit due to factory and plant closures as well as travel restrictions within the country. We will get another glimpse at hard data on Chinese manufacturing at the end of February with the release of China’s monthly PMI data, which is likely to show contraction. 

We would consider an additional elevation of our geopolitical risks rating should one of two things materialize; either a substantial increase in the death rate or evidence of an acceleration in the rate of contagion beyond infected provinces in mainland China (i.e. internationally). Currently, the death rate continues to hover right around 2%, though it has inched a little bit higher in recent weeks and currently stands at about 2.5%. Should that number begin increasing materially, it would suggest to us that either reporting integrity has been below standard or that the virus has been more severe than initially anticipated. With respect to contagion, the incredibly forceful travel restrictions imposed within China seem to have been effective in stalling the spread of the disease. However, should evidence begin to emerge that contagion has reaccelerated on an international scale, this would indicate to us that the significant economic impacts of the disease would not be confined to mainland China. We view such a scenario as low probability at this time, but it is a risk that deserves our ongoing attention.

Politics and Investing With so much news flow coming out of China with respect to the coronavirus, it has been easy to overlook all that has gone on in U.S. politics over the past several weeks. What is particularly interesting about the current state of domestic politics is that it seems there are those on both ends of the political spectrum who voice concerns about what an opposition victory might mean for their investment portfolios. Our belief is that investors should do their best to disentangle politics from investing, as the controlling political party has historically had very little influence on market returns over time. We anticipate that markets may experience short-term bouts of volatility simply as a result of how polarizing the 2020 campaign may be, but we expect the focus of markets to remain elsewhere until we have more clarity on who the Democratic candidate may be. Following the results in Iowa and New Hampshire, it appears that it may be quite some time before that clarity is realized. The first real opportunity to narrow the pack will come on March 3, when over 34% of available delegates will be up for grabs on “Super Tuesday”.

by Connor Darrell CFA, Assistant Vice President – Head of Investments
Global equities recorded healthy gains last week as optimism rose that the economy could remain resilient in the face of the new coronavirus outbreak. At this point, the total impact on economic activity remains impossible to quantify, and investors can expect markets to remain jittery until the virus is eventually contained. We have seen little over the last week that would help us to update our current assessments of contagion and severity. The death rate among those infected still sits at around 2%, and while the rate of contagion has also remained somewhat stable, a recent Chinese research report suggests that the virus can spread in multiple ways. Both of these metrics deserve our ongoing attention, as they can help us to assess the potential magnitude of the disease’s impact on the economy, as well as whether the economic effects will largely remain confined to mainland China.

At present, the most impacted areas of the market outside of Chinese equities have been at the sector level. The travel and industrial sectors, as well as some commodity markets have seen more volatility than most other assets as a result of the immediate impacts of quarantines and reduced global travel demand. The technology sector is one that has continued to perform well but could come under pressure if recent containment efforts in China fall short and the virus is able to spread beyond the Hubei Province. One of the biggest differences between the SARS outbreak of 2003 and the current situation is that China is now a much larger component of the global economy, particularly in the technology supply chain. While Hubei province itself is not a major technology hub within China, there are multiple neighboring provinces which contain key production centers for many key inputs in the production of smart phones, TVs, and semiconductors.

by Connor Darrell CFA, Assistant Vice President – Head of Investments
Global equity markets moved lower last week with concerns over the economic impacts of the coronavirus weighing heavily on investors’ minds. Emerging Markets stocks, of which Chinese equities are a major component, were hit hardest. Large-scale business closures and supply chain disruptions are anticipated to negatively impact economic growth in the near-term, and both stock and bond prices have begun to reflect that uncertainty. The headlines coming out of China with respect to the virus have been unnerving, but a look at prior outbreaks suggests that the market impacts may be relatively short-term in nature. Of course, all outbreaks are unique, and the scientific community still knows very little about the new coronavirus, so it is unsurprising that markets have reacted in the way they have. The situation in China is rapidly evolving, so in order to help keep tabs on new developments, we will be tracking two primary facets of the disease over time; contagion and severity. Below we provide some perspective on both of these key considerations as well as a comparison to prior outbreaks.  We will continue to provide updates to our assessment in future iterations of The Weekly Commentary.

Severity
There remains little clear information about the true severity of the virus, especially as it relates to the impacts on different age cohorts, whether deaths have occurred primarily in higher risk patients, etc. However, we do know that as of Monday morning, confirmed cases totaled 17,489 worldwide (with about 99% occurring in mainland China). Of those cases, the virus has been connected to 362 deaths, translating to a death rate of just over 2%. For context, the SARS (Severe Acute Respiratory Syndrome) outbreak of 2003 had a death rate of 9.6%, while the death rate associated with the seasonal flu is about 0.05% (according to the World Health Organization). One promising datapoint is that there are over 500 cases of patients who contracted the illness and have since recovered and been released from the hospital.

Contagion
While the coronavirus appears to be significantly less life-threatening than both SARS and MERS (Middle East Respiratory Syndrome), it does appear to spread more quickly. During the SARS outbreak, the World Health Organization identified 8,098 probable cases, and that number has already been surpassed by the new coronavirus. Chinese authorities have responded by placing over a dozen cities under quarantine, and travel to and from mainland China has been significantly reduced. As of now, it is the rising level of contagion that seems to be having the biggest impact on markets.

Market History
Evaluating market history can often be a helpful starting point for an assessment of what might be expected in the future. Despite the differences in severity and rate of contagion between the two diseases, the SARS outbreak of 2003 remains the most logical point of comparison for the new coronavirus. During the SARS outbreak (which also originated in China), there was a measurable short-term impact on southeast Asian economies. Economic growth in Hong Kong briefly fell into negative territory, and Chinese economic growth was also impacted. However, the Chinese economy was undergoing a rapid transformation and was exhibiting very high levels of growth during this time period, and so economic output remained quite strong throughout the outbreak. Asian equities sold off during the peak of the SARS hysteria, and other global equity markets also struggled to generate positive returns (though the U.S. market remained quite resilient). Altogether, the outbreak lasted about nine months and both the economy and markets were able to rebound within a relatively short period of time. The chart below summarizes market returns in different regions during the peak of SARS hysteria as well as the ensuing months after authorities began to contain the outbreak. With the SARS outbreak, it is clear that the market impacts were short-lived.  However, it will be important to monitor the current situation for further developments, especially as it relates to the rate of contagion and severity of the new coronavirus.

by Connor Darrell CFA, Assistant Vice President – Head of Investments
Global equity markets retreated from their previous highs last week as evidence emerged that the new coronavirus continued to spread outside of mainland China. About a dozen Chinese cities, including Wuhan at the center of the outbreak, are on lockdown as China’s Lunar New Year celebrations begin. Many public celebrations have been canceled and travel restrictions have been imposed during what is one of China’s busiest holiday seasons. Markets are reflecting concerns over the potential impacts of the virus on the global economy, and we have begun to observe a rotation out of risk assets such as stocks and toward the relative safety of fixed income investments. As a result of this rotation, yields moved lower across most of the yield curve last week, generating positive returns for bonds.

The true economic impact of the coronavirus will not be measurable until after the outbreak has been contained, but many have looked to the SARS outbreak of late 2002 and 2003 for a point of reference. A report issued in 2004 estimated that the SARS outbreak cost the world economy over $40 billion dollars, but the overall market impact proved to be somewhat limited. The major risk to markets at this point in time still stems from the “fear factor” that the new virus is creating, which may ultimately pose a risk to consumer spending and travel expenditures. Adding to the uncertainty is the fact that the virus has an unusually long incubation period of up to two weeks, which makes it likely that current reports are underestimating the number of infected people. However, it is important to note that even if the disease continues to spread, its impacts may still be significantly lower than that of the seasonal flu, which kills an estimated 50,000 people every year. The heightened level of concern surrounding the new coronavirus is likely at least in part due to the simple fact that it is new and foreign. It is human nature for us to have a heightened sense of fear of something that we do not understand and are unfamiliar with.

We have adjusted our assessment of “geopolitical risks” in our heat map to a negative at this point in time to reflect the heightened concerns surrounding the novel virus, but do not believe that the effects will be long-lasting. We will continue to monitor the disease’s impact on the global economy and markets moving forward and will provide additional updates in future commentary.

by Connor Darrell CFA, Assistant Vice President – Head of Investments
Global equities continued to ride the wave of momentum created by the agreement of a “Phase One” trade deal between the U.S. and China and extended their advance into record territory. President Donald Trump and Chinese Vice Premier Liu He finally signed on the dotted line last week, officially stamping the first bit of tangible trade progress to date. The agreement mandates that China increase its imports from the United States by approximately $200 billion and decreases U.S.-enacted tariffs on Chinese goods. Progress has also been made with respect to intellectual property protections and the opening of Chinese financial markets, but much work remains to be done on these two key areas of contention, leaving the door open for additional headline risks and setting the stage for a drawn out negotiating process that could extend beyond Donald Trump’s first term as president. Substantial U.S. tariffs will continue to remain in place as the negotiations continue, but markets have clearly looked positively upon the progress that has been made thus far.

In the bond market, yields remained largely unchanged throughout the week as investors continued to favor risk-assets such as equities. With the Federal Reserve on what is expected to be an extended pause with respect to rate changes, there has been little new to report in terms of monetary policy of late. However, in comments last week, Federal Reserve Bank of Dallas President Robert Kaplan became the first Fed official to explicitly acknowledge that recent actions by the Fed to inject liquidity into the financial system may have led to an increase in investor risk-taking. He warned that the central bank should be cognizant of its impact on risk appetite in financial markets moving forward as it considers future policy changes. Kaplan’s comments echo the sentiment of many market “bears” who have argued that equity market valuations have become stretched as a result of elevated levels of enthusiasm among investors. 

by Connor Darrell CFA, Assistant Vice President – Head of Investments
NOTE: Last week, we reported an incorrect number for the December jobs report, which was not released until 1/10. Refer to the “Heat Map” for more details on the most recent employment data.

The U.S. equity market extended its gains last week as tensions between the U.S. and Iran showed signs of easing. Markets seem to no longer anticipate an escalation in the conflict between the U.S. and Iran following what has been seen as a largely unprovocative response to the killing of Qassem Soleimani on the part of the Iranians. With geopolitical risks at a heightened level, there remains the risk for additional unsettling headlines that could spark volatility, but it is unlikely that any such headlines would have a material impact on global markets.

Here in the U.S., the December jobs report came in weaker than anticipated, though the unemployment rate remained at its 50-year low of 3.5%. Wage growth, which had shown signs of picking up during the latter half of 2019, also came in weaker than expected. The 2.9% annual rate of increase was the lowest reading since July of 2018. Month-to-month jobs data tends to be somewhat unpredictable, and we continue to view the employment situation, and tangentially the U.S. consumer, as the strongest component of the U.S. economy. In the coming weeks, we will be watching the beginning of Q4 earnings season for further insights into consumer spending during the holiday season.

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Equities:
Equity markets closed out 2019 with another strong quarter which helped push the S&P 500 to its highest annual return since 2013. Markets continued to achieve new highs throughout most of the year as central bank rate cuts and robust consumer confidence countered the negative effects of trade uncertainty and declining global manufacturing. We often stress to investors that long-term market performance tends to track corporate earnings growth, but over shorter periods of time, it is common to see stock prices and earnings diverge. In our view, this was a key theme of 2019 as stock prices surged higher despite lackluster earnings growth. We can think of stock investing as simply purchasing the right to a share of the future earnings of a company. Thus, stocks have begun to look more “expensive” since investors must now pay a higher price for the same amount of future profits. An acceleration in corporate earnings growth will likely be needed in 2020 in order to sustain and support recent levels of stock market returns. As we move into 2020, consensus analyst estimates are calling for earnings growth just shy of 10%, which would represent a relatively meaningful acceleration from the flat growth we observed in 2019, but a tempering of return expectations going into the new year may be warranted.

Bonds:
The response by central banks around the world to softening economic activity throughout 2019 was also a boon for bond investors. Much of those gains were achieved during the first three quarters however, as optimism surrounding economic growth began to resurface during Q4 leading to a bounce in Treasury rates. Rates across the yield curve are influenced by expectations for economic growth and inflation, and with the unemployment rate at its lowest level since the 1960’s and evidence of wage growth at last emerging, an argument could be made that an uptick in inflation may not be far behind. Depending upon how significant it is, the emergence of inflation would potentially signal the next step in the maturation of the bull market and could push interest rates higher in the coming year.

Outlook:
The healthy returns achieved across most major asset classes made 2019 one of the best years of the current market cycle. Remarkably, it was largely the exact opposite of what occurred during 2018 when most major asset classes exhibited losses. Over the past two calendar years, the benefits of diversification have been harder to see as many assets that historically behaved differently from one another moved in lockstep. This is largely a result of bond yields sitting so close to their lower bounds, and as such, there are potential implications for the expected risk and return profiles of traditional balanced portfolios. If the correlation between stocks and bonds moving forward is higher than it has been in the past, then the diversification benefits of owning bonds will be diminished. This may create challenges for investors, but the good news is that the economy remains healthy and even began to show evidence of firming up during the fourth quarter. If this trend continues, then the probability of recession will decrease in the near-term and the primary risks to the market will remain geopolitical in nature. And as we have stressed in prior commentaries, market declines related to geopolitical events tend to be far shorter and shallower than those that have a more material impact on economic growth.

VIDEO: Q4 2019 Market Commentary
Connor Darrell CFA, Head of Investments, shares Valley National Financial Advisors’ summary of the fourth quarter as we enter 2020. WATCH NOW

by Connor Darrell CFA, Assistant Vice President – Head of Investments
Typically, our quarterly commentary replaces “The Markets This Week” in our TWC newsletter, but 2020 kicked off with some troubling developments in the Middle East which we anticipate will dominate the news cycle early in the year. As such, we wanted to take the opportunity to provide a summary of our current thinking on the geopolitical environment as it pertains to U.S.-based investors.

On January 2, the United States announced that it had killed Iranian General Qassem Soleimani in an airstrike outside of Baghdad. Soleimani was a key military leader and a revered figure among the Iranian public. The attack represents a significant escalation in tensions between the U.S. and Iran, which have been festering since the Trump Administration’s decision to withdraw from the Iranian nuclear deal and re-impose economic sanctions. Security experts anticipate that the Iranian government will retaliate, and the uncertainty surrounding what that retaliation might entail has caused some minor volatility in equity markets. We have raised our assessment of “international risks” to a 7 out of 10 in our Economic Heat Map to reflect the elevated tensions between the U.S. and Iran. The rest of our Heat Map remains unchanged and we see no metrics flashing warning signs.  Important to our outlook is that we do not feel the increased geopolitical risks pose any threat to the key economic pillars we track, and we do not recommend making any changes to portfolio strategy as a result of this news. 

While we do believe that the attack represents a significant escalation and a meaningful change in tone of the Trump Administration’s dealings with Iran, we do not believe that tensions are at a point where they threaten the long-term stability of markets. We will likely see increased volatility due to headline risks, as well as disruptions in the oil market. However, the supply and demand dynamics at play in the oil market are vastly different than they were even ten or fifteen years ago, and the power of U.S. production is at an all-time high. Even in the face of significant geopolitical instability, we believe there is likely a cap on how high oil prices can push, though we do not know exactly where that cap might be. Investors maintaining a diversified global portfolio are well positioned to deal with short-term volatility in markets, and the evidence of improving economic fundamentals that emerged during the latter half of 2019 bode well for the economic expansion to continue in the near-term. We will continue to monitor the situation closely with particular interest in what Iran’s response might be, but we remain confident that long-term economic fundamentals will be largely unimpacted at this time.

Heads Up!
We are in the process of updating and improving the format through which we report our U.S. Economic Heat Map. We hope that these improvements make the report more informative and useful. Be on the lookout for these updates in the coming weeks!

by Connor Darrell CFA, Assistant Vice President – Head of Investments
The last full week of 2019 yielded additional positive returns for both stock and bond investors. It has been a stellar year for investment returns, with the S&P 500 poised to end the year up over 30% and the Barclays Aggregate Bond index set to close things out with almost a 9% gain. For U.S. equities, this would only be the 15^th time since 1937 that market returns exceeded 30% in a single calendar year. Important to consider however, is that the market’s strong returns this year were generated as a result of what analysts refer to as “multiple expansion” and not earnings growth. Multiple expansion occurs when stock prices rise faster than corporate earnings, meaning that stocks become more expensive on a relative basis. Interestingly, the opposite occurred in 2018, when stocks generated negative returns despite earnings growth well over 20%. Over the long run, it is earnings growth that tends to be the primary driver of returns, and while both 2018 and 2019 produced the opposite result in isolation, when taken together, earnings growth actually does have strong explanatory power over the past 24 months.

Following the significant multiple expansion that took place this year, the current price to earnings multiple for S&P 500 stocks is about 18.1, quite a bit above the historical average of 15.2. Moving forward, if U.S. equities are going to continue to climb higher, earnings growth will need to once again assume the role of primary catalyst. According to Refintiv, analysts are calling for mid to high single-digit earnings growth in 2020, which would be a marked improvement over 2019 earnings growth. Whether this is enough to support higher than average multiples remains to be seen. Investors can take solace in the fact that the underlying economy continues to show evidence of firming up and that the U.S. consumer remains on solid footing, both of which should help to support corporate earnings throughout the next year.

by Connor Darrell CFA, Assistant Vice President – Head of Investments
Global equity markets recorded another solid weekly gain as momentum from the announcement of a “phase one” trade deal between the U.S. and China continued to bolster investor sentiment. The gains helped push some U.S. indices further into record territory just in time for the holidays, a stark contrast from the state of markets during last year’s festive season. Markets also appeared to react positively to some healthy economic signals, which showed an increase in personal income and spending, as well as some healthy housing data; all of which bode well for the U.S. consumer continuing to support the economic expansion. Bond yields climbed a bit higher in response to the evidence of a solidifying economic backdrop, which led to small losses for bond investors.