Weekly Market Commentary, January 7, 2020

The Markets

The new year and decade started off where the last one finished as major stock market indexes opened the year by reaching new highs. The good spirits, supported by continued progress toward a Phase One trade deal with China, boosted markets.

On Friday, those good spirits were challenged by potential risks after the killing of Iranian General Qassem Soleimani in Baghdad by a U.S. military drone. The attack came as tension has increased between the two countries following rocket attacks against U.S. bases, U.S. air strikes, and attacks against the U.S. embassy in Baghdad.

Market reaction was predictably negative, but rather muted. The S&P 500 edged just 0.1 percent lower last week. The global MSCI ACWI was basically unchanged as a weaker U.S. dollar supported emerging market stocks. The Bloomberg BarCap Aggregate Bond Index rallied 0.4 percent. The S&P finished 3.0 percent higher in December and 9.1 percent higher for the fourth quarter. A positive bump in the last two days of the year pushed the 2019 S&P 500 return to 31.5 percent.

The U.S. employment report on Friday will cap a busy week of economic data, as some releases were delayed by the holiday. Expectations are for continued healthy job growth with 160,000 new jobs expected. Job growth of above 100,000 means the economy is producing enough jobs for those entering the labor force.

Data as of 1/3/20	1-Week	Y-T-D	1-Year	3-Year	5-Year	10-Year
Standard & Poor's 500 (Domestic Stocks)	-0.2%	0.1%	32.2%	12.7%	9.9%	11.1%
Dow Jones Global ex-U.S.	0.2	0.4	19.7	7.4	3.8	2.6
10-year Treasury Note (Yield Only)	1.8	NA	2.6	2.5	2.0	3.3
Gold (per ounce)	2.5	1.7	20.0	10.4	5.2	3.3
Bloomberg Commodity Index	0.0	0.6	5.1	-1.9	-4.8	-5.4

S&P 500, Dow Jones Global ex-US, Gold, Bloomberg Commodity Index returns exclude reinvested dividends (gold does not pay a dividend) and the three-, five-, and 10-year returns are annualized; and the 10-year Treasury Note is simply the yield at the close of the day on each of the historical time periods.

Sources: Yahoo! Finance, MarketWatch, djindexes.com, London Bullion Market Association.

Past performance is no guarantee of future results. Indices are unmanaged and cannot be invested into directly. N/A means not applicable.

Rewards, Risks, and Vulnerability

2019 ended cathartically. Performance last year was phenomenal. The last quarter was very positive, and many stock market indexes reached new highs before edging lower the last day of the year. The major issues affecting markets – U.S.-China trade, Brexit, and Federal Reserve policy plans – all became clearer in December. The turning of the calendar month also wrapped up a decade of strong returns for U.S. stocks, and the absence of a recession aided performance.

As the accompanying table shows, U.S. stocks experienced a phenomenal 10 years. After enduring the tumult of the financial crisis, the U.S. economy rebounded at a slow and steady pace. Despite worries to the contrary, the economy never went into recession and, by some measures, accelerated. Unemployment reached a 50-year low and wages increased.

Index	2010s Performance
S&P 500	13.6%
MSCI ACWI	8.8%
BBGBARC US Agg Bond	3.7%
RUSSELL 2000	11.8%
Top 10 Yr. Sector: Technology	16.8%
Bottom 10 Yr. Sector: Energy	1.4%
Top 10 Yr. Style Box (M*): Lrg. Growth	15.0%
Bottom 10 Yr. Style Box (M*): Sml. Value	10.7%

Source: Morningstar Direct; Sector Data uses MSCI Sectors and style box data uses Morningstar Indexes

Over the last decade, the United States bested global markets, and technology was the top performing U.S. sector. Asset classes with greater emphasis on technology tended to perform well. U.S. stocks have a larger exposure to technology than the rest of the globe, and growth stocks have more of a technology tilt than value stocks.

One mistake investors often make is to assume returns were inevitable and smooth. Investors over the last 10 years bore myriad risks, worries, and uncertainties. The returns were their reward.

The clarity experienced on a number of key issues lies in stark contrast to the news in recent days. Risk returned to markets with potential aftershocks from the death of General Soleimani. As was true several times over the last decade, this geopolitical event poses a risk to markets. We must seek to understand the ramifications policy decisions will likely have on our portfolios.

General Soleimani and Iran have been engaged in exporting conflict and terror throughout the Middle East in recent decades. U.S. policy has focused on making sure Iran doesn’t export much else. The United States has actively sought to tighten the economic noose on Iran by limiting the countries to which it can export oil and other trade goods. Because of the sanctions, Iran’s economy is weak, and its direct impact on global markets is relatively small.

The two risks we see as most relevant are increased violence and Iran successfully curbing the oil flowing from other nations in the Middle East. The muted market reaction to the killing suggests most investors don’t see the risks as particularly high. The S&P 500 fell just 0.7 percent and oil rose less than 4 percent. Reprisals are expected, but neither Iran nor the United States are anxious for escalation into an extended conflict, especially a full-out war.

The risks from the oil market have been mitigated by two important factors. First, the global economy is less energy-intensive than in the past. A greater emphasis on services and improved fuel efficiency have reduced oil’s importance. Second, the United States is now an energy exporter, and, if prices increase and oil from the Middle East can’t reach Asia and Europe, it has the ability to scale-up production for export.

We wrapped up last week’s review with this sentence: “The potential for strong returns is possible, but it comes with the willingness to bear risk.” This week serves as a good reminder the types of returns we have seen in the last decade were earned by bearing discomfort and concern.

Fun Story

Pork or a Toaster

[In preparation for the Lunar / Chinese New Year, we will be featuring stories on China over the next few weeks.]

In the 1970s, U.S. banks were limited on the interest rates they could charge customers, so they gave away toasters and other gifts to stand apart from the competition. Rather than toasters, Chinese banks are seeking deposits by addressing the shortage of pork. Swine flu has forced the Chinese to cull 60 percent of its pigs. The Chinese take a week off for the Lunar New Year, and pork demand spikes during this period. Small banks are seeking to take advantage of the situation by holding a raffle for a larger supply of pork. In order to enter to win, individuals must open a new account at the bank. I hope the winner brings something in which to carry the pork home.

Sources:

https://www.axios.com/jerome-powell-interest-rates-2019-73b78462-04f8-4f77-8aff-eee25f35f803.html

https://www.wsj.com/articles/investors-bail-on-stock-market-rally-fleeing-funds-at-record-pace-11575801002 (or go to https://peakcontent.s3-us-west-2.amazonaws.com/+Peak+Commentary/01-06-20_WSJ-Investors_Bail_on_Stock_Market_Rally_Fleeing_Funds_at_Record_Pace-Footnote_2.pdf)

https://www.philadelphiafed.org/-/media/research-and-data/regional-economy/indexes/leading/2019/leadingindexes1119.pdf?la=en

https://www.foxbusiness.com/markets/us-manufacturing-sector-contracts-for-sixth-month-in-a-row

https://www.lawfareblog.com/us-and-china-strike-phase-one-trade-agreement-washington-steps-efforts-block-chinese-tech-amidst

https://www.axios.com/growing-economic-divide-between-two-americas-d1d94b84-f1fb-4a37-9444-76aab1ad8ad9.html

https://en.wikipedia.org/wiki/Twitter_Revolution

https://www.reuters.com/article/us-iraq-security-soleimani-insight/inside-the-plot-by-irans-soleimani-to-attack-us-forces-in-iraq-idUSKBN1Z301Z

https://www.barrons.com/articles/dow-jones-industrial-average-finds-reason-to-drop-after-u-s-air-strike-on-iran-51578105152?mod=hp_DAY_6 (or go to https://peakcontent.s3-us-west-2.amazonaws.com/+Peak+Commentary/01-06-20_Barrons-The_Dow_was_Waiting_for_a_Reason_to_Drop_The_US_Air_Strike_Supplied_It-Footnote_9.pdf)

https://www.bbc.com/news/business-14536235

https://www.livescience.com/biggest-science-of-the-decade.html