Investor exuberance around a combination of accommodative central bank policy and improved prospects for global trade explained most of the market returns through 2019. The close of the calendar year represented a complete reversal to how major indices ended 2018. Twelve months earlier, stocks tumbled sharply on worries about trade tensions impacting global growth, and investors feared that interest rate increases would turn a slowdown into a protracted drawdown.

Despite the sharp recovery in January 2019, it still took six months for the S&P 500 to definitively erase those year-end losses. Even allowing for seasonally low volumes exaggerating market movement, the parallels between both types of outsized market moves cannot be ignored. In the US, the S&P 500 returned in excess of 28% over the course of 2019, nearing the 29.6% growth achieved in 2013. The 2019 rally was not limited to US stocks. The euro Stoxx 600 gained 23% this year, putting it on course for its best performance in a decade. China’s Shanghai Composite was up 22%, while Japan’s Nikkei 225 rose 18%. The turnaround was driven primarily by a shift in monetary policy at the US Federal Reserve, which cut rates for the first time in a decade in July, lowering them again in September and October. Since then, the stock market’s gains have been broad. The S&P 500 set 35 record closes in 2019, the most since 2017. The tech sector led much of the advance in markets through 2019. The S&P 500’s tech sector rose 47% during the year, by far the biggest gain among the index’s 11 sectors. Nonetheless, gains were broadly distributed, with approximately 90% of the stocks in the S&P 500 having risen during the year. Improved sentiment and emboldened investor expectations followed the additional stimulus from major central banks, as demand for risk assets was boosted.

The US dollar weakened through late December as investors steered away from “safe haven” assets. The main dollar index sank to levels close to the lows of July. More recently, markets were emboldened by the apparent thaw in trade tensions, culminating in the US and China announcing a “mini” trade deal. Despite the seasonal boost to markets’ spirits, there was little evidence, however, that the Trump administration was reversing its strategy of trade and technology protectionism as a means of achieving future substantive concessions. With an election year in 2020, the market may remain wary of further uncertainties ahead. Moreover, by year-end, price mechanisms appeared to be further detached from market fundamentals. Compared with the sharp gains in US stock prices, companies in the S&P 500 have reported subpar growth in both earnings and revenue in 2019. Earnings per share growth will be just 1.4%, according to FactSet data, down from 22% in 2018. Profits are expected to grow 9.5% in 2020.

The disappointing returns were generated in an environment which continues to prove challenging for the overall investment process. The impact of blending style characteristics to determine stock forecasts continued to result in anomalous factor outcomes through 4Q19. While their predictive power persists, the inversion highlighted earlier in the year appeared to accelerate towards year-end.

Performance was weak across most stock selection criteria throughout the period. At a portfolio level, it proved challenging to blend value with a series of our other factor sets. The nature of the relationship between value and momentum detracted from the fund’s returns during the period. This was evidenced by the weaker contribution from the market dynamics factor set. As price mechanisms within the broader market demonstrated further decoupling from fundamentals, weaker returns were seen to some of our more fundamental stock selection criteria. Against this backdrop it remains too early to evaluate comprehensively the impact of the recent enhancements to the fund’s investment model, specifically those incorporating downside risk considerations into our dynamic weighting scheme.

The inversion of cross-sectional variables highlighted above was particularly pronounced in the market dynamics and dynamic valuation factor sets. This transitory effect has coincided with an extended period of deleveraging and capital outflows from a wide range of quantitative strategies. The underlying momentum strategies within market dynamics were further impacted by the effects of the broader factor unwind at the start of September. In the case of dynamic valuation, we believe the latest model enhancements will better mitigate the downside risk in periods where both value and quality go out of favour, by decreasing the weights in both. Factor sets more dependent on fundamental inputs, such as sustainable growth, were negatively impacted by the decoupling between price mechanisms and fundamentals at the market level. The analyst sentiment component, which focuses on company level information, further detracted from performance. By contrast, the company management criterion, which evaluates the nature of the underlying corporate team responsible for running companies in our investment universe, contributed positively over 2019.