While the global economy extended its post-crisis recovery in 2019, growth occurred at its slowest pace since the global financial crisis. Despite the headwinds from a weak global economy, trade disputes, geopolitical tensions, and social unrest, it was a strong year for global equities.
- Political and trade-related headlines fostered an environment of uncertainty
- Global economic momentum receded, despite notching another year of positive growth
- Central banks relented on monetary policy tightening, with the U.S. Fed cutting rates 3 times
- Non-U.S. stocks underperformed U.S. stocks, with emerging markets lagging all year
The U.S. economy grew for the tenth consecutive year in 2019, buoyed by strong consumer spending and a healthy job market. While recession alarms began to sound earlier in the year, that appeared to have been averted in the short term. The Fed’s 75-bps of interest rate cuts, new repo programs, and “QE Lite,” a $60 billion Treasury bill purchase program, helped provide relief.
Following a weak 2018, there was concern central banks had few remaining levers to pull to avert a slowdown. This proved to be an underestimation, as in addition to the U.S. Fed, approximately 40 other central banks cut rates more than a combined 60 times. Emerging market rate cuts in particular were numerous and helped limit trade war induced damage but further exhausted central bank tools to reverse any additional slowdown.
The global economy began 2019 in an uncertain state, with concerns including U.S.-China trade tensions, a slowing manufacturing base, and Brexit prominent among a host of political and social fractures. The U.S. Fed’s willingness to be “patient” in light of global developments, and ultimately the “pivot” to a more accommodative policy stance was critical in setting a floor for the economy. Although the perceived threat of a U.S. or global recession intensified through the summer, widespread policy accommodation and progress toward key resolutions fostered a more constructive outlook by year-end.
The relative strength of the U.S. economy, favorable interest rate differentials, and its status as the world’s reserve currency caused the USD to appreciate broadly for most the year. The emerging markets currency basket faced ongoing headwinds, given concern over global trade dynamics and the impact on developed market growth.
Chinese policymakers spent most of the year implementing a variety of stimulative monetary and fiscal policies in an effort to mitigate trade disruptions and to achieve targeted growth. While key structural reforms remain necessary going forward, the obvious impact of China’s fortunes on countries across the globe required a shorter-term focus.
The U.S. economy completed its tenth year of expansion in 2019 with generally strong fundamentals, particularly consumer spending and unemployment. Year-over-year growth in real GDP stands at 2.1% for the most recent reporting, representing a downshift from the prior year’s above-trend results which benefited from the passage of Federal tax reform.
Core CPI increased to 2.3% by the end of the year, but this is a figure the U.S. Fed appears willing to let drift higher in the quarters ahead. Despite having added 2.1 million jobs in 2019, wage growth is not excessive at 2.9% year-over-year. With 111 consecutive months of job growth, the unemployment rate matches the 50-year low of 3.5%. Consumer sentiment and personal consumption were well-supported throughout 2019, helping to carry the economy through the distractions of the trade war and the slowdown in manufacturing.
The housing market regained momentum as the Fed’s rate cuts led to lower mortgage rates and housing starts rising more than expected in the latter half of the year. Despite enduring three consecutive monthly declines between August and October, the Conference Board’s index of 10 Leading Economic Indicators was relatively steady throughout the year.
Global Long-Only Equity
Global equities enjoyed a robust 2019 marked by an MSCI ACWI increase of 27.3% and solid gains across the globe. The year, notwithstanding a relatively depressed starting point, began with strong upward moves in the first two months. Global headlines then drove investor consternation (U.S./China trade tensions, Brexit, concerns of global economic slowdown, Hong Kong protests) resulting in seven months of volatility and a sideways trade. Ultimately investors moved back to a risk-on mentality in mid-October as concerns were mitigated from accommodative global central bank postures, announced progress on U.S.-China trade and a possible, less disruptive resolution to the Brexit saga. Despite a brief rotation to Value at the end of the third quarter, Growth style indices outpaced their Value counterparts again this year.
U.S. Large Caps led in 2019 with the S&P 500 returning 31.5% for the year. U.S. Small Caps also advanced nicely with the Russell 2000 up 25.5%, generally following a similar pattern as the large caps. Gains in the U.S. were broad-based across sectors, highlighted most meaningfully by 40%+ moves in IT, with the exception of Small Cap Energy which posted a single-digit decline.
International Markets posted double-digit advances but trailed U.S.-based peers. Developed markets advanced 22.7% for the year as measured by the MSCI EAFE, with most countries tallying gains while Emerging Markets gained 18.9%. The U.S. dollar was broadly higher for much of 2019, strengthening vs. the Euro and Yuan, but weakening vs. the Yen and Sterling.
Global Long/Short Equity
Market volatility was present (both positive and negative) during 2019. With heightened macro impacts, especially during an election year, we anticipate continued volatility will be the norm for 2020. An environment such as this typically helps to generate opportunities on both the long and short side, so equity long/short managers should stand to benefit.
Equity long/short managers generally had a strong showing in 2019, participating in market up moves while also protecting in drawdowns. Taking advantage of volatility, to provide both beta and alpha, is exactly what is desired from the equity long/short asset class. Gross exposure started 2019 near a multi-year low and ended the year at the highest level in more than five years, demonstrating increased optimism since mid-year when exposures were weighed down by macro concerns. Net exposure, which was low for most of the year, increased during 4Q as managers reported positive company-specific data but remain concerned about potential market uncertainty due to political events.
Style exposure was a major contributor in 2019 as momentum/growth drove performance, both positively for most of the year as well as negatively in September and October. Managers with significant exposure to technology and health care saw the highest swings. Financials remains the most underweighted sector by equity long/short managers.
Brexit concerns caused European exposures to decrease to a multi-year low, but this reversed in 4Q as hope for a Brexit resolution drove European exposure to the highest level since 2015. Asia exposure also increased through the year, predominantly driven by China, as Japan exposure remains near historic lows.
Global Private Equity
Purchase prices continued their climb to record heights. The average price for a new LBO in the U.S. rose to 12.0x EBITDA in 2019, up from 10.6x in 2018. Although some point to the composition of the completed sales as being heavy on technology and software companies as one reason for 2019’s spike in pricing, it is not the only reason. Fundraising continues to be strong and private equity sponsors have over $1 trillion in uninvested commitments ready and waiting to deploy. This uninvested capital puts upward pressure on all transaction prices.
Exit activity was resilient in 2019 as evidenced by the continuing strength of the U.S. IPO market. Although the number of IPOs fell from 192 in 2018 to 160 in 2019, the amount of capital raised remained steady at over $46 billion for the second consecutive year.
The year was highlighted by Uber and Slack, which rank as two of the 10 largest U.S. IPOs of all-time. The year ended on a sour note as investors soundly rejected WeWork’s accounting and governance missteps. Bitter medicine for WeWork investors but a much-needed sanity check for public and private investors alike.
Outside the U.S., new transaction private equity activity slowed in 2019. In Asia, political unrest underscored by ongoing protests in Hong Kong dampened large scale dealmaking. Across the region, total transaction values fell almost 40%year-over-year. The drop-off in activity in Europe of 25%, mostly attributed to Brexit uncertainty, was not as severe, but still meaningful.
Global Real Assets
The NCREIF Property Index (NPI) posted its 38th consecutive quarter (9.5 years) of positive appreciation in 3Q. This is 16 quarters longer than the second longest winning streak since the benchmark’s inception in 1978. For the year, the NCREIF’s annualized income return (a proxy for cap rates) has held steady at 4.4%.
Fundamental indicators remain strong across the four primary NPI property types with year-over-year income growth ranging from 2% – 8% and occupancy levels hovering above 94%, the all-time high for the index. The story of 2019 was the substantial headwinds faced by the retail sector, and more specifically, the mall sub-sector. These assets were written down substantially to start the year. Although overall transaction volume remains robust, a lack of bidders for saleable mall assets leaves the sub-sector searching for a bottom. Necessity and grocery-anchored retail assets continue to see solid transaction activity and fundamentals.
Overall, real estate assets continue to benefit from an ongoing economic expansion that has taken employment levels to new highs. The Fed’s mid-year switch to a policy easing stance should also provide continuing, indirect support for real estate assets through low borrowing costs and a potential extension of this economic cycle.
The Bloomberg Commodity Index (BCOM) rose 7.7% in 2019, underperforming the BloomBar U.S. Aggregate Bond Index by 1.0%, the S&P 500 by 23.8%, and the MSCI ACWI by 19.6%. Solid gains for gold and oil were offset by losses across natural gas and many base metals and agricultural products.
Global Traditional Bond Markets
U.S. and global growth concerns drove risk-free rates lower throughout most of 2019, while robust demand for income allowed lower-quality credit to perform quite well. The Federal Reserve’s “pivot” to a more accommodative stance led to rate cuts in July, September, and October and renewed balance sheet expansion. The Committee’s latest projections suggest the targeted range for short-term rates will remain 1.50% to 1.75% throughout 2020. The U.S. Treasury yield curve (10’s – 2’s) ended steeper after briefly inverting in late August.
Given sensitivity to domestic interest rates, the BloomBar U.S. Aggregate clearly outpaced expectations in 2019 with a total return of 8.7%. Despite modest losses to end the year, returns were positive in all four quarters. IG corporate credit was a top contributor given the 60-bps contraction in spreads. The benchmark’s yield-to-worst is currently just 2.3%.
Despite a brief mid-year interruption in investor risk appetite, the High Yield bond category returned an impressive 14.3% in 2019. Index level spreads tightened a remarkable 190 bps during the year, and the meager yield-to-worst of 5.2% is approaching all-time lows.
Municipal Bonds were solidly positive, with the notable flattening of the tax-exempt yield curve rewarding investors with maturities beyond five years. A relatively strong fundamental backdrop and persistent category inflows allowed lower-rated credits to outperform.
Unhedged Global government bonds underperformed with the drag of a strong U.S. dollar tempering the benefit of lower-trending yields. Emerging Market outcomes were robust.
Global Nontraditional Fixed Income
Liquid Absolute Return strategies within our peer group produced an average return of just over 6.5% during 2019. The willingness to tactically assume modest portfolio duration alongside diversified credit exposures was a defining characteristic of outperformers. Managers implementing more defensive strategies, including meaningful cash reserves or credit hedges, tended to lag but remained universally positive. We continue to believe the diversification of risk factors within portfolios remains valuable, as this aids in downside protection and reduces key correlations. Outperforming risk-free cash becomes easier as policy rates head lower, and enhanced volatility in rates, spreads, and currency should provide alpha opportunities.
Long/Short credit strategies broadly generated gains in 2019 despite lacking the duration tailwind of their more interest-rate sensitive, traditional fixed income counterparts. Managers also had to contend with an environment in which performance dispersion between high yield bonds and loans weighed on results within loan-heavy strategies. In the event-driven category, avoiding pitfalls was key to generating good performance. Some distressed managers struggled as several widely held names performed poorly for those who didn’t get the timing quite right. With credit spreads tight, expect to see managers continue to employ a cautious approach, but volatility could create opportunities for long/short credit.
Private Credit strategies (typically five- to ten-year fund life) offer the opportunity to earn both a credit spread and an illiquidity premium versus publicly traded fixed income strategies. Credit quality mattered in 2019 as higher rated BB/BB-spreads tightened on average while lower rated B+/B spreads widened noticeably.
Disclaimers: The data contained in this report is provided from Asset Consulting Group (ACG). This is not an offer to buy or sell securities. No investment process is free of risk and there is no guarantee that the investment process described herein will be profitable. Past performance is not indicative of current or future performance and is not a guarantee. In preparing these materials, we have relied upon and assumed without independent verification, the accuracy and completeness of all information available from public and internal sources. Gryphon Financial Partners shall not in any way be liable for claims and make no expressed or implied representations or warranties as to their accuracy or completeness or for statements or errors contained in or omissions from them. This was created for informational purposes only. Gryphon Financial Partners, LLC is an Investment Adviser.