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4th Quarter 2018 Market Update and Review

The global stock markets in 2018 ended in a maelstrom of volatility. The markets declined significantly in the fourth quarter, this being the second major pullback of the year. This marks the first time in nine years that the S&P 500 posted a negative return for the year (-4.4%). Most developed markets had double-digit declines with some defensive asset classes turning in positive results. The global sell-off in the fourth quarter was driven by concerns of slowing global growth, trade issues, and the central banks reduction of monetary easing.

Asset Class Performance Over the Last Twelve Months:

CASH

  • Throughout 2018, the Federal Reserve raised the Fed Funds Rate higher. As such, yields on cash assets rose throughout 2018.
  • At the beginning of 2018, the 3-month T-Bill was yielding 1.44%; by December 31 st , the yield had risen to 2.45%. This represents a significant increase of 70% in cash yields.

BONDS

  • Bond yields continued to rise as the Fed increased rates in response to an improving economy.
  • The Fed resumed their balance sheet reduction which pushed rates higher.
  • Short-term bonds earned positive returns while long-term bonds declined. Over the last twelve months, the US Treasury Short Bond Index was up 1.89%, while the longer-term US Treasury 20+ Year Bond Index was down -1.98%.
  • Foreign bonds (Bloomberg Barclays Global Agg ex-US, US Dollar Hedged) turned in a 2.4% return over the last twelve months.

Q4 Equity IndexesSTOCKS (see chart above):

  • With the market gyrations of 2018, most equity asset classes turned in negative returns, while the defensive asset classes of Utilities and Healthcare were positive.
  • The Dow Jones Industrial Average was down -5.0% for the last year and was down -14.0% in the latest quarter. The more broadly-based S&P 500 Index was down -5.3% over the last year and was down -14.4% in the fourth quarter.
  • International equities (as measured by the MSCI EAFE Index) were down -12.5% for the most recent quarter and turned in a -13.8% return for the last year. European equities (MSCI Europe) were down -14.3% over the last year. The Pacific Rim markets were negative with Japan (MSCI Japan) down -12.6%, while Asian stocks (MSCI Asia-Pacific ex Japan) posted a -13.7% return over the last year.
  • Domestic utilities provided a 3.4% return (MSCI USA Utility Index) over the last year due in part to a move towards more defensive positions.
  • Technology stocks suffered a decline of -17.0% during the fourth quarter. Despite the substantial drop, technology finished the year down a modest -5.5% (MSCIACWI Information Technology).
  • Energy stocks turned in a -12.6% return (MSCI ACWI Energy Index) for the last year as oil prices moved lower with slowing demand and increasing supplies.

12-24 Month Outlook:

  • U.S. GDP (Gross Domestic Product) slowed to 3.5% in the third quarter of 2018 after the second quarters robust 4.2% growth rate. Projections indicate some slowing over the next four quarters as interest rates continue to climb and the tax cut stimulus becomes normalized into the economy.
  • In December, U.S. Leading Economic Indicators declined 0.1% following a 0.2% increase in November. The Leading Indicators are an important guide for future economic growth. The Coincident indicators increased 0.2% for the month of December, while the Lagging indicators increased 0.5%. These statistics indicate some near-term slowing of the domestic economy. This information is not finalized as the government shutdown has affected the ability to acquire the latest government data.
  • Global central banks continue to reduce quantitative easing. As a consequence, the IMF (International Monetary Fund) cut its forecasts for world economic growth in 2019 to 3.5%, down from a 3.7% forecast in October. The IMF forecast for 2020 indicates a 3.6% growth rate.
  • December inflation in the U.S. came in at 1.9%, down from 2.2% in November. This was the lowest inflation rate since August 2017. A reduction in gasoline prices was the main cause of the drop in the rate. We expect the U.S. and global inflation rates to increase modestly over the next several years.
  • The Fed is expected to continue raising rates as they reduce their balance sheet which is currently at $4.047 Trillion. Interest rates are expected to rise for the foreseeable future.
  • The unemployment rate was 3.9% domestically in December, an increase of 0.2% from the previous month which was the lowest rate since 1969 (almost 50 years). Unemployment is projected to increase modestly over the next several years.

Investment Strategy Moving Forward:

  • CASH – Money market funds are now paying rates just above 2.0%. Notwithstanding, yields on many savings and money funds are still well below 1.0%. For now, our cash allocations will remain low.
  • BONDS – The Fed has made it abundantly clear that they intend to raise rates for an extended period to lower their balance sheet. With that in mind, we will avoid long-term bonds as rates continue to rise. Our approach is to hold short-duration bonds in the portfolios for the foreseeable future. International bonds should do well as central banks will need to refrain from raising rates to protect their fragile economies.
  • STOCKS – Looking forward, our outlook remains positive in equities. Stocks look favorable due to continued GDP growth, reasonable valuations, low unemployment, and improving consumer demand.
    • Our largest asset class, Domestic Large-Cap stocks, should continue to benefit most from the domestic economic improvement. Small caps may experience some headwinds as their valuations have been expensive.
    • European stocks remain attractive for the long-term as their valuations are cheaper than the U.S. markets. The European economy is facing headwinds as the ECB is cautiously reducing monetary stimulus.
    • Growth in Asia continues to improve, but there are concerns of a trade conflict. China is the main area of concern with a slowing economy and trade issues.
    • With the increasing inflation rate, we believe commodity-based asset classes (Energy and Precious Metals) should have good growth potential in the years ahead.
    • Lastly, technology-based equities should do well in an improving economic environment with lower market valuations.

We remain positive, notwithstanding the most recent market correction. The year 2018 was a rollercoaster beginning with the runup in January, followed by a drop in early February through March (a market correction of over 11%). Subsequently, the markets slowly climbed back to new record highs (DJIA closing high 26,828 on Oct. 3rd).  Valuations became pricey while the Fed continued to raise rates, this resulted in a significant correction (DJIA closing low 21,792 on Dec. 24th). This was a decline of 5,036 points (or -18.8%).

Economically, we have positive domestic GDP growth, significant corporate earnings, historically low unemployment and an improved corporate tax policy. We expect the consumer will add to overall growth in the economy with unemployment at historically low levels. All of this should bode well for the domestic economy.  Globally, market valuations are not as lofty as the U.S., but also have more room to grow in an improving world economy.

At this point in the economic cycle, we expect continued global growth with low-to-slightly higher inflation. There are no meaningful indications of an economic recession occurring in the near-term. The most notable issue for the markets is the Fed increasing interest rates. As such, we continue to maintain a bullish stance moving forward.

Please let us know if you have any questions on the overall strategy and holdings in your personal portfolio. We are always happy to chat about your individual financial situation. We greatly appreciate the confidence you have shown in our services. Thank you for your business!