MARKET BRIEFS: Q4 2018 RECAP AND Q1 2019 OUTLOOK

What to Expect Toward the End of a Bull Market   |   Q3 2018 Market Overview   |   Let the Good Times … Slow

Introduction
In 2018, US investors experienced negative returns in almost every major asset class. The exception to this was US bonds which had a return for the year of 0.0%⁴. Every other asset class, both domestic and international, declined in value for the year. This was a particularly alarming turn of events for US equity investors who, as recently as last quarter, were enjoying year-to-date returns of 10.6% and strong economic fundamentals that provided a promising near-term outlook⁵. A mere three months later, full year returns for US stocks were negative 4.4% and negative 8.9% for global stocks⁶.

The precipitous drop in stock prices during the third quarter left investors shaken and worried that they were experiencing the beginning of the end of an almost 10-year stock market bull run and left them wondering whether prudence dictated paring back the size of their stock allocation. This was especially true on Christmas Eve when investors had experienced nine consecutive down-market days. Investors weren’t just anxious they might get a lump of coal for Christmas, they were pretty sure they were watching the coal truck backing up and making a giant delivery.

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• The year ended with a bang with all the equity markets seeing large drops in December leading the full-year returns for most equity indices into negative territory. For the year, the US large caps returned -4.4% (S&P 500) while US small and mid-caps returned -10.3% (S&P 1000). Smaller caps are more impacted by the swings in the domestic economy and concerns over rising rates and the ability of small caps to service floating rate debt in a slowing economy weighed on the market.
• Within the US, three sectors managed a positive return in 2018, healthcare 6.6%, utilities 4.1% and consumer discretionary 0.8%. Lower interest rate sensitivity and reduced political risk with the split Congress aided healthcare along with having characteristics of growth. The defensive bias in utilities and smallest drop in return year-end allowed utilities to be a top-performer for the year. Energy hit bear market territory during the fourth quarter and led to a loss of 18.1% for the year – plunging oil prices along with slowing global growth and tariff concerns impacted the sector.

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The story
After returning 11% through the first 3 quarters of 2018, the S&P 500 tumbled 14% during Q4, bringing the annual total return to -4%. Amid indications that global growth has slowed, market commentators and politicians have called for the Fed to pause further interest rate increases. The Fed Funds futures market is pricing a 54% probability of no change to the fed funds rate by the conclusion of the December 11, 2019 meeting and a 35% probability of a reduction of 0.25%.¹

The reality
Say what? The US economy is clearly, thankfully, slowing from an unsustainably high rate to a level which is still above its structural potential. The unemployment rate is so low that we economists are scratching our heads (with all three hands!), wondering why there is no wage growth. And, even after the almost-bear market, broad US financial conditions are still more expansionary than just prior to the first interest rate increase of this cycle (in December 2015).

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¹ See https://www.cmegroup.com/trading/interest-rates/countdown-to-fomc.html.