Fourth Quarter 2018 Investment Commentary

The fourth quarter left investors with a punishing dose of red ink, arising from concerns on a number of fronts. Investor weariness ratcheted up at the end of

2018 providing a December to Remember–though not in a jolly way.  In fact, it was the worst December on record caused by uncertainty surrounding trade, the Federal Reserve, a government shutdown, and global economic growth as we headed into the New Year.

Global equity and fixed income markets ended 2018 in negative territory with every major index in both developed and emerging markets falling**. Specifically, the S&P 500 Index dropped 4.4% (after dividends,) while  the  S&P  400  Mid  Cap  Index  lost 11.1%
and the Russell 2000 Small Cap Index declined 11.0%.

The broad index of international stocks, EAFE, declined 13.8% while emerging markets were off 16.6%. China’s benchmark Shanghai Composite Index topped off the bad news, off almost 23 percent for the year.

Why We Have Volatility

Some analysts perceive the latest market pull back as a normal course correction resulting from the transition to a higher rate environment and from slowing growth prospects. Market pullbacks are common when the market experiences a shift in sentiment and tries to decipher which sectors and industries can benefit under the new environment.

Uneasiness in the markets was amplified by a rapid fall in the price of oil, which declined to levels not reached since late 2017. Analysts attribute the slump to a rising supply of oil as well as the perceived slowdown in the global economy.  Oil’s price decline is one more obstacle to stock indices recapturing their recent losses.  Some investors view the demand level for oil as an indicator of global economic health.

Market volatility has also been attributed to year-end tax selling, but the most violent moves appear to be the result of computer-driven algorithmic trading.

Against the several factors fueling market volatility, pension funds are among the more stabilizing factors that helped equity markets recover towards the end of December.  Pensions allocate to equities for the long term rather than being focused on short-term trades. The billions of dollars invested under pension funds help promote the overall stability of the markets.

Fixed Income & Interest Rates

The Fed has raised rates nine times since it began tightening rates from near-zero three years ago. The Fed originally signaled that it expects to raise rates at least twice in 2019.  Recent comments by Fed Chief Jay Powell have led some investors to believe there may be fewer (or no) increases this year.  Some analysts believe that the Fed may continue to raise rates, in order to be able to lower them as a form of stimulus should economic conditions deteriorate.

Earlier in the year, following the lead of our Federal Reserve, nearly every developed-country central bank began reversing monetary stimulus and started tightening rates.  The anticipation of rising rates and less accommodative policy served as a hurdle for smaller emerging market economies in need of inexpensive capital.

The resulting volatility often provides a benefit to bonds.  In spite of our low unemployment rates, the benchmark 10-year Treasury bond ended the year at

2.69%, down from a mid-year high of 3.24% reached in November. Interest rates also returned to accommodative levels around the developed world, as both China’s and Europe’s economy show signs of slowing. Whether a recession is on the horizon is debatable, but low rates appear to be needed to keep the global economy moving forward.

U.S. short-term bond yields rose, closing the gap with longer-term bond yields and nearly flattening the Treasury bond yield curve.    The slope of the yield curve is closely followed by market analysts—many of whom believe that an inverted yield curve portends a recession. After the dust settled, the broad U.S. Aggregate bond index ended the year almost back to breakeven levels.

With inflation in check, and given a volatile stock market ladened with the threat of ongoing trade tensions with China, we see interest rates remaining low for the first few months of the year. This reprieve in interest rates should be a boon for home buyers who are worried about rising rates and about the possibility of a slowing housing market.

The Government Shutdown

At first, it appeared that a government shutdown would be avoided.   This changed after the Senate approved a stopgap spending bill with $1.3 billion for border security but the House rejected the compromise.  President Trump responded by asserting that he wouldn’t sign a bill unless it included $5.6 billion for a border wall with Mexico.   The reopening of the government is now at a stalemate over the funding of the border wall with a resolution nowhere in sight at this time.   In fact, the current shutdown has sadly set a record for its duration.

The costs of the shutdown are still unknown, with lost wages, exports, and government services essential to the operation of private sector businesses being adversely affected.

Market Outlook

Looking forward, in spite of a turbulent 2018 there are many positives as we enter 2019. The market selloff has moved market valuations to more attractive levels, both in the U.S. and abroad.    This compared to somewhat frothy valuations earlier last year. Corporate earnings growth looks to remain at reasonable levels, according to most analysts’ estimates and GDP growth may remain above trend.

Unemployment and inflation remain low while wages are modestly rising and consumer spending and industrial production remain strong.   If you look at current conditions without the backdrop of the past quarter, some might even describe it as a goldilocks environment.

And yet, there remains considerable risks and uncertainty, though the market has gotten off to a strong start so far in January.  After balancing both the risks and the rewards, we are positioning most of our managed accounts near their target allocations at this time.

Summing Up

Investors need patience and foresight to weather market declines. We employ diversification as a tool in designing and managing portfolios.  It does not always save the day, but helps avoid the significant risk of placing one’s financial eggs in a single basket.   We endeavor to maintain an overall disciplined asset allocation approach, while attempting to tilt portfolios away from risk or uncertainty to help manage volatility at the margin.    We “harvested” tax losses in accounts, where appropriate, to help mitigate tax liabilities.

We look forward to discussing your investments as well as your financial needs and any concerns.

*All index returns and other statistics are provided by, unless otherwise noted.
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