The past year proved to be a difficult one when it came to forecasting how the stock market and economy would perform, especially after 2018 ended with the worst December since the Great Depression, according to John Lynch, chief investment strategist at LPL Financial.
However, although LPL’s positive stock market outlook “proved too conservative,” the firm managed to get “more right than wrong for 2019,” he said in the firm’s latest weekly market Commentary: “2019 Hits and Misses.”
One standout prediction that LPL got right was its forecast that large-caps would perform better than small-caps, he noted.
“We came into 2019 favoring benchmark-level exposures to large and small cap stocks while urging some caution as the economic cycle matured,” he recalled. LPL also anticipated that additional progress on trade would help large-caps, he noted,
In a commentary on March 18, 2019, “Movin’ On Up (In Market Cap),” the firm projected better performance for large caps relative to small caps and, “in a timely move, reduced small cap stock exposure in some of our model portfolios,” he said.
Although the “path on trade was longer and bumpier than we anticipated, the large cap Russell 1000 Index has outperformed the small cap Russell 2000 Index by 6.6 percentage points since March 18, 2019,” he pointed out. Also, as of Dec. 30, the Russell 1000’s 31.1% return was about 5 percentage points ahead of the 26.2% return for the small cap Russell 2000 Index, he noted.
A second major area that LPL projected correctly was cyclical sector leadership, he said. “Favoring the most economically sensitive, or cyclical sectors, worked in 2019, particularly technology,” he said, noting it had “topped all S&P 500 sectors with a return of 49.5%” as of Dec. 30. The “next-best performers — communication services, financials, and industrials — also were “cyclical and have each posted year-to-date returns near 30%,” he pointed out.
“Not favoring 2019’s worst performing sector — energy — was also helpful, though we did maintain limited exposure to underperforming but higher-yielding master limited partnerships in income-oriented portfolios during the year,” he added.
Heading into 2019, LPL had also favored U.S. equities over those in developed international markets throughout the year, he said, adding: “Concerns about economic growth, global policies, and low interest rates drove our caution on European and Japanese investments last year.” That’s a view LPL has maintained in “Outlook 2020: Bringing Markets Into Focus,” he noted.
Lynch pointed to one final area as a hit on the list of 2019 projections. “In early 2019 in many of our managed portfolios, we reduced cash allocations in favor of actively managed, high-quality short-term bond strategies, which contributed to returns,” he pointed out.
He went on to point to three main predictions that LPL got wrong: Growth vs. value, emerging markets and interest rates.
In LPL’s Outlook 2019 publication, it recommended that suitable investors consider tilting equity allocations toward value in expectation of a pickup in economic growth and the firm’s belief that valuations for growth stocks had become stretched, Lynch recalled.
However, he conceded: “The pickup in economic growth did not materialize, mainly because of trade tensions, and valuations seemed to matter only in September, the one month of the year during which value stocks outperformed growth stocks materially. The Russell 1000 Growth Index has returned 36% year to date, outpacing its value counterpart by nearly 10 percentage points.”
LPL had also maintained a modest allocation to emerging market equities in 2019, mainly because of a relatively strong economic growth outlook, attractive valuations and an expected resolution to the U.S.-China trade dispute, he said.
However, trade tensions instead “escalated further and lasted longer than we had anticipated, which put emerging markets in the miss column — although the 18% year-to-date return is certainly respectable,” he said.
The 10-year U.S. Treasury yield, meanwhile, “sat at 3.01% at the end of November 2018, so our forecast for a gradual rise to 3.25%, the low end of our initial forecast range, hardly seemed farfetched at the time,” he noted.
However, what ended up happening was that “rates tumbled from there amid slowing global economic growth, continued U.S.-China trade tensions, rate cuts by the Fed, and falling — and negative — sovereign bond yields throughout Europe and Japan,” he said.
All of those factors “eventually led to an inverted yield curve,” he pointed out. LPL “ended up lowering our rate forecast twice during the year, with the latest move in August to 1.75–2%,” he noted.
Although that was “clearly a miss, credit-sensitive positioning of our fixed income allocations within portfolios was beneficial and provided an offset to our decision to emphasize short- and intermediate-term rather than long-term bonds,” he said.