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The year opens with muted economic forecasts. While the economy grew at 2.3% in 2019, GDP is expected
to grow at only 1.8% this year and next. While the investment discussion of Q4 2019 was dominated by the
risk of recession, it appears that this risk itself is receding. The current projections indicate that although
growth has decelerated, the economy is going to continue to grow.
Unemployment is low, and forecasted to remain low throughout the next couple of years. Conditions in the
labor market indicate a shortage of skilled workers in many industries, which should bolster consumer
spending, even in the event of possible weakness in the economy. The US continues to display the strongest
economy and markets worldwide.
On the other hand, interest rates are artificially low, which may spur inflation. The rest of the world (with
the exception of China) appears to be coming out of a period of poor economic conditions. This could lead
to changes in the balance of currencies and international trade at a time when there are substantial frictions
in these areas. And an election year in the US is certain to bring controversy, if not uncertainty to the
economy and the markets.
The stock market ended 2019 at all-time highs, with the S&P 500 closing at 3230.78, a gain of ~28.8%. All
indications are that the rally is set to continue at least for a short while, despite the fact that corporate profits
are only expected to grow at less than half the pace they did last year. The VIX Index, which tracks
volatility expectations, is at very low levels, showing a lack of fear in the market. This combination, high
stock prices, low fear of risk, and a definite catalyst (lower expected profits) leads to higher than average
risk of a “correction” of 10% or more in a short period. Economic conditions suggest that any such move
would be short-lived, because of strength in the labor market and presumably, consumer spending. At the
very least, investors should brace for increasing volatility going forward.
The 10-year Treasury is yielding 1.88 at the start of 2020, versus 2.69 at the beginning of 2019, a significant
drop. The year saw substantial changes in the shape of the yield curve, which even inverted for much of the
year, meaning that short-term rates were higher than long-term ones. An inverted yield curve is indicative
of stresses in the economy, and signals a high probability of recession in the near future. In November, the
curve resumed a more normal rising shape, which signals a reduction in perception of economic risk. We
are expecting rates to remain stable in the short-term, but note that current levels are not sustainable in the
long term, they are likely to rise.
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