What Was the Last Quarter All About?
This has been the most “unloved” bull market ever. Folks have been nervous all the way through and we’ve had a number of sell-offs along the way. The severity of the 2008-09 decline and the lingering effects of that recession kept lots of folks looking over their shoulder for the next bout of bad news. But through all that nervousness, the economy made progress and stocks inevitably followed suit.
As you have most certainly noticed, the last quarter was a tough one for investors of all stripes.
The economy is still, despite worries, moving forward. The last market decline, however, brought us within a whisker of having to declare the end of the bull market and the beginning of a bear market (declines of 20% are generally the yardstick) but, at least as we write this, we’ve managed to hold off this particular distinctive event for some future time.
As always it is difficult to tell just what trajectory the economy and markets will assume in this brand-new year. We’re left with reading tea leaves, crystal balls and looking at fundamentals like corporate earnings growth, valuation measures, leading and coincident economic indicators and the growth in the economy, which are primarily the criteria that move markets over the long term. Yelling “fire” and running for the exits is not generally considered a fundamental measure of the health of the economy and markets.
It is important to note that fundamentals remain reasonably strong, even as stocks and other risk assets have fallen in value. In fact, the market decline has significantly improved one of those fundamental measures, namely valuation. If you liked the stream of projected earnings from some of your favorite companies at September’s stock price, you might like it even more today.
Mainstream economists tell us that the economy is still growing and, just as importantly, that it is likely to continue to do so for some time. Folks are working, unemployment is at historical lows, businesses are firmly in the black and earnings are expected to grow further, just not as quickly, perhaps, as they did in 2017 and 2018.
So why was (seemingly) everyone selling? And why have stock and commodity prices fallen? Over shorter periods markets reflect the mood of the moment from day to day and month to month. The “cause du jour” this time is more nuanced. If we had to distill it down to one word it would be “uncertainty”. The recent tariff regimen and fears of resulting trade wars have spawned uncertainty and, as tends to happen, this uncertainty has multiplied with worries about the price of oil, what the Fed will do with interest rates, and other less glamorous concerns.
Longer-term, however, markets are always about the fundamentals. When these events happen, they create the possibility of better and more compelling valuations and opportunities for those who are diversified and have the patience and fortitude to stay invested.
Below is a look at the major asset classes, what they have done, and what we might anticipate going forward:
Fixed income markets were challenged from several fronts in 2018. Short term interest rates have risen, pushed higher by the Federal Reserve in a couple of different ways. Rising rates typically result in a more difficult environment for existing traditional fixed rate bonds; results however, were mixed this year. While long-term rates also increased they did not move as quickly as some had expected due to modest expectations for inflation. The net result was a flattish total return for broad bond markets for the year.
Foreign bond returns were mixed as a strengthening U.S. dollar during 2018 acted as a general headwind for international investments of all types—especially fixed income, where absolute rates of return tend to be lower to begin with.
While lackluster performance in this asset class can be attributed in one part to currency fluctuations, concerns over global growth and the increasingly charged U.S.-China tariff spat, which carried investor worries toward emerging markets, also contributed.
U.S. stocks experienced substantially more volatility than they had the prior year, where every month had ended with a positive total return—a historical oddity for U.S. stock indices. Instead, 2018 featured multiple -10% price corrections and substantially more uncertain sentiment. While 2017 was a very strong year for stock returns 2018 turned decidedly negative with the much watched S&P 500 index dropping 6.2% versus a 21.8% gain for 2017 (as reported by Standard & Poor’s).
In developed markets, slower growth in Europe and Japan as well as a strong U.S. dollar held returns below those of U.S. equities. On the positive side, historically, such performance divergences between domestic and foreign equities over time have often tended to normalize and eventually reverse, with foreign stocks currently in the position of holding the advantage of far more attractive valuations.
This sector is especially sensitive to interest rates and the Fed’s rate increases had a dampening effect on the portion of your portfolio invested in real estate issues here in the US. You do have exposure to international real estate as well and those issues were weak both from an exchange rate perspective and from some of the same uncertainties that hurt international stocks in general.
Commodities lost ground in 2018, with the bulk of the asset class’ volatility stemming from extreme changes in the price of crude oil during the year. Following double-digit gains early, due to rising demand prospects and cuts in production by several nations, prices reached multi-year highs. While higher prices are challenging for consumers, investors in the commodity asset class benefit from such conditions. Later in the year, however, as production ended up higher than expected, oil prices plummeted.
Looking at the fundamentals we see some attractive market valuations after the last several months of selling. The economy should remain supportive as GDP is widely expected to grow in 2019. Corporate earnings should follow suit, continuing to expand, though perhaps not as robustly as we saw in 2018. It is likely that we will continue to have some jitters around the continuing trade tariffs and folks will hang on the news out of the Fed in regards to interest rates.
The old adage tells us the “markets climb a wall of worry”. If we continue to see the types of fundamentals many economists project for 2019, we could very well see markets rise from what appears to be a discounted position, and more in line with what one might expect given current projections for economic growth and corporate profitability.
In the meantime, if you have any questions or concerns, please reach out to us.
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