In the fourth quarter, stocks added to an already stellar year. US stocks were up 9.1% for the quarter with Technology and Health Care leading the way, each sector was up over 14%. The forward P/E ratio on the S&P 500 Index was 18.2x on December 31, 2019 as stocks reached more record highs. For reference, the 25-year average P/E ratio is 16.3x earnings.
International stocks also had an excellent quarter, ending up 8.9%. While continuing to lag US stocks for the year, they posted solid double-digit gains for 2019. The fourth quarter showed signs of a stabilizing global economy which could continue in 2020.
The Treasury yield curve steepened over the fourth quarter (short-term rates fell and longer-term rate rose) but the curve remains exceptionally flat. The 10-year Treasury yield rose from 1.68% to 1.92%, while the 1-year Treasure yield fell from 1.75% to 1.59%. The Fed has signaled that they will hold the Fed Funds rates steady for now.
Below is a table highlighting various market index returns over the past 3, 12, and 36 months:
COMMENTARY:
It was easy to be an investor in 2019 as both equity and fixed income investments had excellent years. US stocks were the strongest asset class of the year with a gain of 31%. Not only did the market end on highs, but there was very little in the form of setbacks for the market. The largest intra-year decline for the S&P 500 index was just -7% (2018’s intra-year decline was -20%).
This level of strength is unlikely to happen again. That’s not to say that the markets cannot continue to march higher. The previous two times stocks returned 30%+ in a calendar year, the following year saw increases of more than 10%. Keep in mind that valuations at that time were not near where they are today.
After a run in stocks as we saw in 2019, especially this far into a bull market, overall equity allocations have likely moved above your long-term targets. Now is a great time to look at your allocations and bring them back in-line with your targets given that equity markets are at all-time highs and the elevated P/E valuations that we see on the S&P 500 Index (as seen on the next page). We have been rebalancing client accounts throughout the year.
The purpose of rebalancing is to maintain a target risk level. This, in turn, helps smooth the ride as asset classes go through cycles. By rebalancing your account, you are forced to sell what has done well (high) and buy the asset classes that have not kept up (low). By taking profits and reducing the risk level in your portfolio back to target, when the market corrects (it’s inevitable) you will hopefully have the ability to move back into stocks to bring your stock allocation back up to target. On the other hand, if you were already at your max risk level, you may not have the capacity to take advantage of the stock sale.
Ultimately, you may miss out on some gains during strong markets, but your portfolio should not fall as much as you would have during down markets compared to not rebalancing. By staying at your target allocation, you will be more likely to stick with it when times are tough and smooth the returns along the way while generating good average returns.
The SECURE Act
In December, Congress passed the Setting Every Community Up for Retirement Enhancement (SECURE) Act. This is the first major change to retirement since 2006. There are more changes that involve business retirement plans but we will focus on the changes that are aimed at helping you save more in your retirement accounts.
A key provision of the bill increases the age at which individuals must begin taking distributions from their retirement accounts. The age requirement was increased from 70 ½ to 72 years old. If you turned 70 ½ in 2019, you will continue to fall under the old rules, but for those that had not attained age 70 ½ by December 31, 2019, you will have a few extra years before you are required to take withdrawals.
The Act eliminates the maximum age at which a person could contribute to an IRA. Prior to the Act, a person could not contribute to an IRA after they turn 70 ½ years old. Starting in tax year 2020, as long as an individual has earned income, they are eligible to contribute to an IRA.
The age at which individuals are eligible to make Qualified Charitable Distributions (QCD) from their IRA was left unchanged at age 70 ½. This means that you are still able to donate to qualified 501(c)3 organizations directly from your IRA without recognizing the distribution as income. There are some special rules to speak to your accountant about if you make a contribution to your IRA after age 70 ½ and then plan to use the QCD.
There were significant changes to the so-called “stretch IRA” rules. Previously when an individual inherited a retirement account, they were able to stretch the distributions over their expected lifetime. Starting in 2020, the new rules state that non-spouse beneficiaries who are more than 10 years younger than the IRA owner will have to deplete the account within 10 years. This has the potential to have major implications for estate planning.
There are many nuances to the Act, if you have questions please reach out to us by email or phone and we will be happy to discuss them with you.
JR Geld, CFA, CFP®
jgeld@hwafinancialgroup.com
Philip E. Huber, Jr, CPA, CFP®
phuber@hwafinancialgroup.com
HWA Financial Group
3448 Ellicott Center Dr.
Suite 101
Ellicott City, MD 21043
410-696-4025