The break down in stocks was driven by a trifecta of classic economic and market concerns emanating from underwhelming corporate earnings guidance, suddenly lackluster economic growth and disappointment towards Federal Reserve monetary policy.
Stocks initially dropped in early October as the third-quarter corporate earnings season disappointed markets. While most companies beat consensus estimates, as they often do, profit warnings from select multinational and industrial firms such as PPG Industries (PPG) and FedEx (FDX) highlighted growing concerns from analysts about peak earnings growth for U.S. corporations. That rising concern was reflected by the market’s performance during the heart of the third-quarter reporting season, as the S&P 500 declined 6.84% in October.
After a respite from selling in November that saw stocks bounce back slightly from the October losses, earnings concerns were compounded in December by suddenly disappointing economic readings. In early December, multiple economic indicators including manufacturing surveys and the November jobs report missed Wall Street consensus estimates, adding the potential of slowing economic growth to the list of headwinds on stocks.
Finally, uncertainty regarding U.S. monetary policy in the wake of the December rate hike by the Federal Reserve added yet another source of concern for investors, and that additional unknown caused a massive spike in market volatility in late December. Specifically, the Fed increased interest rates for the fourth time in 2018, despite the declines in stocks and wavering economic data, and signaled it expects to increase rates two more times in 2019. That policy decision, which was more restrictive than investors were hoping for, caused stocks to plunge as the major equity indexes dropped to fresh 52-week lows during the final two weeks of December. Markets did bounce modestly during the final days of 2018 to finish off the worst levels of the year, but still solidly negative on an annual basis.
While broad US markets were all down for the year, commodities such as oil and gold, suffered greater losses due in part to the continued strength of the dollar for most of the year. A similar fate was suffered by international markets which saw yearly declines of more than 13% for developed international markets and over 14% for emerging markets.
Despite the legitimate concerns about economic growth, earnings and Fed policy, the news in the fourth quarter wasn’t all bad.
First, the U.S. and China agreed to a temporary trade war “truce” and began an intense, 90-day negotiation period aimed at ending the trade war.
Second, the European Union and the Italian government reached a compromise on Italy’s proposed 2019 budget that satisfied European Commission rules, thereby avoiding a political showdown.
Lastly, most major indicators of U.S. economic growth, while exhibiting a loss of momentum, remained in solidly positive territory, meaning the economy is still growing (albeit, potentially at a slower pace). The November Employment Situation Report showed positive jobs growth and an unemployment rate under 4% while regional manufacturing surveys remained in positive territory.
In sum, 2018 was a very difficult year in the markets and for investors. Not only did most major stock indices post a negative full-year total return for the first time since 2008, but the declines came with two episodes of intense, confidence-shaking volatility in the first and fourth quarters. That being said, 2018 was not 2008; this is the perfect time to reflect on risk tolerance and adjust your portfolio accordingly if you found this volatility kept you from sleeping well.
So what are our expectations for 2019?
At a minimum, we can expect continued volatility in stock, bond and commodity markets in the coming months. And, whether the markets continue the fourth-quarter declines or rebound will depend largely on the resolution of those three uncertainties facing markets: Earnings, economic growth and Fed policy.
Regarding earnings, the bulk of the fourth-quarter 2018 earnings results will be released this month, so within the next few weeks we should learn whether U.S. corporate results have stabilized, or whether the disappointing guidance we saw from companies in Q3 continued. Apple certainly did not help the volatility picture, when kicking off earnings season with less than stellar results this week and, most importantly, downgrading their future expectations, citing concerns about the trade tariffs. Yet we have quickly followed a horrible day with a huge positive given the great employment report. Such is the stuff of volatility.
We understand the risks facing both the markets and the economy, and we are committed to helping you effectively navigate this challenging investment environment. In your portfolios here, we had several risk-off triggers hit during the prior quarter and given the continued volatility, have not seen the stability we need to see to return to those positions. A measured approach will likely be the solution for this year as we continue to work with you to ensure your investments are in line with the needs of your financial plan.
Welcome to a new year!