Fourth Quarter 2018 Commentary

DATE: January 1, 2019
FROM: David G. Dietze, JD, CFA, CFPTM, Founder and President
 

I.  Performance Update

For the second time in 2018 volatility exploded to the upside with stocks selling off hard, led by Tech and the mighty FAANG stocks. Investors witnessed the worst December for stocks since 1931! Perception changed dramatically among investors from cautious optimism about future growth, to fear of possible recession. Those fears, along with China’s need for quantitative easing, increased rhetoric around tariffs, uncertainty regarding Brexit, a collapse in the price of oil, and concerns about the future of the EU, put pressure on risk assets. Investors once again embraced safety in high quality bonds, gold, and utility stocks during the final two months of the year. 
 

   MARKET DATA

Fourth

Quarter

2018

 

 

2018

S&P 500 (dividends reinvested)

-13.52%

-4.38%

NASDAQ (dividends reinvested)

-17.30%

-2.84%

60/40 S&P 500 / TX-EXEMPT SECURITIES BLEND

-7.56%

-1.86%

DOW JONES INDUSTRIALS (dividends reinvested)

-11.29%

-3.51%

INTERNATIONAL STOCKS (MSCI EAFE IX ID)

-12.59%

-13.84%

TAXABLE BONDS (Barclay’s 1-3 Yr Gov’t/Credit)

1.18%

1.60%

TAX-EXEMPT SECURITIES (Barclay’s Muni Index)

1.69%

1.28%

 
Expectations for Federal Reserve’s future monetary policy changed markedly throughout the year. For nine months the fear among investors was how far and fast would the Fed raise interest rates? During the final quarter that perception changed to, will the Fed need to cut interest rates soon? The Fed itself said it is approaching a “neutral” stance on rates. It did reduce the expected number of forecasted rate hikes in 2019, but that didn’t satisfy equity investors.
 
Those that thought the stock market was volatile for 2018 should look at the US 10-year Treasury. The yield on the US 10 Year rose from 2.4%, up to over 3.25%, and all the way back down to 2.7% during the year. This movement mirrored the confusion and uncertainty of investors around future economic growth. 
 
In the second half of 2018, short term bonds sold off hard and caused the yield curve to flatten. Investors could earn more on their bonds that matured in 1-3 years than they could for those bonds maturing 4-5 years. Historically, there has not been a recession without a preceding inverted yield curve, but not every inversion has been followed by a recession. 
 
Tariffs between the US and China were the new risks factored into stocks during the year. The trade tensions continued to escalate with the US currently taxing over $200bil of Chinese goods. This has slowed Chinese economic growth, which seems to be reverberating into the global economy. If there is a resolution to this issue, risk assets should rally. If this continues, expect continued pressure on global economic growth.
 
The further out the risk curve investors went, the bigger the losses. Emerging market and small cap stocks got hit the hardest. Cash and T-bills provided the gains. 
 
                                PREVAILING YIELDS AS OF:

FIXED INCOME ASSET

12/31/17

3/31/18

6/30/18

9/30/18

12/31/18

US Government 10 Yr. Note

2.40%

2.79%

2.85%

3.06%

2.69%

5-Year Certificate of Deposit

1.00%

1.67%

1.74%

1.89%

2.02%

Money Market

0.95%

1.32%

1.57%

1.75%

2.08%

 

II. Looking Forward

Volatility is the norm for stocks. What is scaring investors today has been the length of the sell off, nearly three months. Investors have not had to handle a down market this long since the summer of 2011. However, stock valuations across most sectors look attractive. Those investors remaining disciplined to their long-term investment goals and financial objectives can find very attractive investment opportunities today. 
 
 

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