TWELVE MONTHS OF ACQUISITIONS, GROWTH AND BROADENED CAPABILITIES MEAN MORE OPTIONS FOR OUR CURRENT AND FUTURE CLIENTS.
In 2019, First Merchants Corporation completed its acquisition of Monroe Bank and Trust in Monroe, Mich., and welcomed the Monroe team. At the same time, we continued our integration in Fort Wayne and our expansion into the Lakeshore region in Illinois and northwest Indiana and in the Columbus, Ohio, market.
But our growth and expansion were not limited to geography. In all of our markets, we continue to broaden the available solutions for our clients through the expansion of our Wealth Advisor and Private Banking team.
In Private Banking, we expanded both in personnel and capabilities. Clients can now enjoy total balance sheet management, including deposit and cash flow solutions and private, customized lending.
We also added key professionals in Corporate Retirement Plan services, allowing us to offer more detailed, customized guidance for business owners and plan sponsors in addition to our current fully bundled retirement plan offering.
2019 Market Summary
What a difference a year makes. In 2018, there was almost no place to hide from market volatility. The decade-long bull run was threatened by a combination of overly aggressive tightening in monetary policy from the Federal Reserve and investor fears of slowing global economic growth amid rising geopolitical tensions. Even though many of the same underlying tensions remained in 2019, it was
a different story entirely for financial markets.
You can see the divergence between the two years in the table at right. Almost all asset classes outside of high quality U.S. bonds ended 2018 in the red, just to come roaring back in 2019 to recoup those losses and then some. Large cap U.S. equities led the way in recovery as the S&P 500 index returned 31.5% including dividends in 2019 after falling by 15% in the final quarter of 2018. High-growth technology stocks proved to be the biggest winners, with the S&P 500 tech sector posting 47% gains for the year.
What allowed for such high returns in the face of so much uncertainty?
Progress on geopolitical conflicts may be front of mind as Brexit and the U.S.-China trade war dominated headlines in 2019. Easing trade tensions certainly played a role in encouraging risk in investor sentiment, particularly in the last quarter as the U.S. and China made a preliminary agreement on a phase one trade deal and agreed to stem the tit-for-tat tariff increases. However, several other fundamental factors were at work in shaping financial market returns in 2019.
Perhaps the most significant driving force behind the rebound can be attributed to the Federal Reserve’s 180° pivot in monetary policy. In 2018, the Federal Reserve hiked interest rates four times and indicated at the December meeting that another two to three rate hikes were in order for 2019 as the Fed believed rates remained too accommodative. Financial markets quickly showed the Fed their disagreement. Market participants rapidly sold risk assets to end the year as they believed the U.S. economy could not support further tightening amid slowing global growth, geopolitical conflicts and fading benefits from tax reform.
In response, the Federal Reserve changed course in January, announcing it would pause on further interest rate hikes. As the year went on, long-term rates dropped due to an outlook of slowing economic growth, and the yield curve became inverted in August, which created significant worry. The Federal Reserve responded with three 0.25% rate cuts in the second half of the year to ease financial conditions and sustain our economic expansion, completely reversing its plans from late 2018. The resulting flood of liquidity fueled a rebound in demand for risk assets like equities as fears of recession subsided and bond yields presented a less attractive investing alternative.
Another factor in the outcome of stock market returns was forward-looking expectations for corporate profit growth. Following earnings growth of 21.9% for the S&P 500 constituents in 2018, which was driven largely by tax stimulus, earnings for the S&P 500 actually fell by 0.02% in 2019, based on the preliminary estimates from FactSet. The stock market returns for those two years may seem surprising in light of their respective earnings growth, but the market is a forward-looking machine. Most of the benefits of tax reform to occur in 2018 and the resulting corporate profit growth was already baked into stock prices in 2017. In 2018, the outlook for corporate profit growth in 2019 soured considerably, as 2018 had set such a high bar, and the stimulus from tax reform and the ensuing share repurchase frenzy were expected to fade. But the outlook for 2020 is looking more optimistic, with the consensus earnings growth forecast currently sitting at 9.5%.
Throughout the turmoil of 2018 and the subsequent rally of 2019, the resiliency of the U.S. economy, and the U.S. consumer in particular, has allowed the bull market to live on. U.S. GDP growth is expected to hit 2.3% in 2020 over 2019, which is down from 2.9% in 2018 but a solid growth rate nonetheless. The domestic consumer supplied about 85% of GDP growth in the first three quarters of 2019. The picture remains solid for the domestic consumer with unemployment near 50-year lows, wage growth in excess of inflation, and consumer confidence at high levels. In the year ahead, market participants are hoping business investment will start to pick up some slack to supplement this performance. Easing uncertainty from progress in the U.S.-China trade war could be part of the recipe in reviving it.
MORE THAN A DECADE SINCE THE GLOBAL FINANCIAL CRISIS
The end of 2019 marked the end of an exceptional decade for the U.S. stock market, which saw an uninterrupted bull market run. The price of the S&P 500 index advanced 190% over the course of the 2010s. If you go back just a few months earlier to the trough of the global financial crisis on March 9, 2009, the S&P 500 actually climbed 377.5% by the end of 2019. Including dividends received, the gains on the S&P 500 since that date would total nearly 500%.
Of course, buying in at the depths of the financial crisis and holding on throughout the past decade would have been much easier said than done, even for investors with the most ironclad stomachs. This bull run has been tested time and time again by crises and conflicts, including a European debt crisis, an Ebola outbreak, a Chinese stock market crash and currency devaluation, an oil-price collapse, and trade wars to boot. Through it all, our team at First Merchants Private Wealth Advisors (FMPWA) helped clients put these crises and conflicts in perspective with the fundamentals, such as diversifying against undue risk and staying the course in meeting their financial objectives.
EQUITIES: U.S. MARKET EXTENDS ITS OUTPERFORMANCE
In 2019, the broad U.S. equity market (represented by the MSCI USA index) posted a total return of 31.6%, more than 10% higher than the 21.3% return for the global equity market excluding the U.S. (represented by the MSCI All Country World ex-USA index).
For the last 12 years, FMPWA has carried a notable underweighting of international securities to the benefit of our clients. While the U.S. financial system made the effort to recapitalize following 2008, many international financial systems, including the Eurozone, did not undertake reparations to the same extent and remain notably undercapitalized. The stability of the U.S. financial system and the attractiveness of its sovereign debt yields relative to a bevy of negative rates around the world have boosted inflows to U.S. securities and enhanced the value of its currency. The U.S. market has also had greater exposure to innovative industries within the tech and health care sectors that have been a boon to corporate profit growth.
While we’re maintaining this allocation decision for now, we will continually reevaluate it with a close eye on future valuations, the strength of the U.S. dollar, and other catalysts that could drive momentum in the other direction. We will also continue to search for and invest in many foreign companies that we have identified as best in class, regardless of domicile.
FIXED INCOME: INTEREST RATES MARCH LOWER
U.S. interest rates took a wild ride in 2019, with the 10-year Treasury yield starting the year at 2.68%, dipping as low as 1.46% to start the third quarter, and rebounding back up to 1.92% to end the year. The Treasury yield curve sounded off alarm bells in August when it became significantly inverted with long-term yields falling below short-term yields, an indicator that has historically preceded all U.S. recessions. In response, our team evaluated the inversion in context. We sent out a client communication saying that such an indicator shouldn’t be taken lightly, but that the strength of the U.S. economy had not yet provided us with confirming evidence of near-term recession.
At year-end, the yield curve, though relatively flat, has been restored to its normal upward slope, easing investor anxieties heading into the new year. It took three 0.25% rate cuts from the Federal Reserve to drop the short end of the curve and an improving economic outlook on consistently strong employment-based data and easing trade tensions to boost longterm yields upward.