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.