Plum Street Advisors
Q4 2018 Market Commentary – January 8, 2019
What a difference a quarter makes. At the end of the third quarter consumer confidence was approaching peak levels, US growth was strong, and the stock market was rallying. Just three months later, the market has become very concerned about the slowdown in global growth, Fed rate hikes, and the tariff war with China. Suddenly stocks have dropped sharply while defensive positions like government bonds and gold have gained.
Overall, 2018 was a year the markets would just as soon forget. As detailed below, US stocks fell 5%, international stocks fell 14%, and commodities did worst of all, giving up 15% for the year. Cash, bonds, defensive currencies like the dollar and yen, and precious metals did relatively better and helped with diversification, but it’s almost impossible to find an asset class that really performed well for the year.
Still, the US economy is strong and corporate earnings remain solid. While the markets are clearly gearing up for an eventual end to the current cycle (the current recovery will soon reach 10 years – the longest recovery in our nation’s history), it seems likely a downturn will not occur in 2019 as many fear. GDP is expected to grow a respectable 2.5% – 3.0% in 2019 according to Moody’s and other economic forecasters.
Factset is projecting Q4 2018 corporate earnings to be up 15% year over year – the fifth straight quarter of double-digit earnings growth. As of year-end, Factset projected 8% growth in year-over-year corporate earnings for 2019, not quite as high as recent tax cut-fueled increases, but impressive and steady growth nonetheless.
Admittedly there are risks on the horizon – particularly possible policy missteps which could have significant impacts in early 2019. Markets seem to be focused on these risks, but an event like a near-term resolution of the US-China trade war could quickly help to lift the market’s spirits.
The U.S. stock market was one of the worst performing asset classes in the quarter – especially the riskier segments like small cap and growth stocks. The broad market Russell 3000’s total return was -14.3% for the quarter and the index ended the year down -5.2%. International markets as measured by the MSCI ACWI ex-US index (which includes emerging markets) fell slightly less in the quarter (declining -11.5%), but posted an even worse full year return of -14.2% in US Dollar terms.
In the U.S., small cap stocks trailed larger stocks in the quarter and for the year. The small cap Russell 2000 index’s total return declined a disappointing -20.2% for the quarter and ended the year down -11.0%. For the quarter, the large cap Russell 1000 total return was -13.8% and for the year the large cap index fell -4.8%.
For the time being, the generally accepted story of steadily rising interest rates is dead. The Fed raised rates again in December from a range of 2.00%-2.25% to a range of 2.25%-2.50%, but the markets are expecting the Fed to pause now.
The long-term 10-year government bond staged a remarkable retreat in the fourth quarter, with the yield falling from 3.1% to 2.7% – a level that almost wiped out all of the interest rate increases of 2018.
For the fourth quarter, the Bloomberg Barclays U.S. Aggregate Bond Index (representing investment grade U.S. bonds) rose by 1.6%, as bond prices move in the opposite direction of yields. The rise helped somewhat offset stock market declines in balanced portfolios. For the year, the U.S. Aggregate Bond Index return was flat.
Overall, commodities had a very poor year in 2018, with the S&P GSCI futures index declining -15.4% for the year, amid a stronger US Dollar, increasing trade friction, and concerns about Chinese demand. Oil prices fell off the table in the fourth quarter, with WTI Crude futures falling from $73 per barrel at the end of the third quarter to $45 per barrel on 12/31. Gold ended 2018 slightly down, but it was a rare bright spot among commodities for each of the last three months of the year and gained 7.7% for the fourth quarter.
The US Dollar strengthened in 2018. The WSJ Dollar Index, which measures the US currency’s performance against a basket of 16 other currencies, climbed 4.3% for the year, negatively impacting emerging market countries with significant dollar-denominated debt. For the fourth quarter though, the dollar was essentially flat, and for the time being, concern about emerging market debt – of which a record $2 trillion is set to come due in 2019 – has abated as interest rates declined.
The US still seems to be in a positive trend as far as the underlying economy – improving corporate earnings with some of the highest profit margins on record, low unemployment and rising wages, and growing GDP. Fears of a recession in 2019 seem premature. Still, the market likes to look far out on the horizon and has calculated in recession risks for the coming years. It has become increasingly volatile from one day – when an Apple earnings warning seems to suggest the end of the recovery – to another when strong labor numbers seem to prove this will easily be the longest recovery on record.
Each piece of news, from Fed interest rate announcements to trade talks with China, from corporate earnings to auto and retail sales, seems to be pushing the market strongly in one direction or another. The encouraging news is that asset correlations are holding up as recent declines in the stock market have come with gains in traditional safety assets like bonds. Diversification still seems to be the best way to weather this storm.