2018 4th Quater Recap and Outlook for 2019
3 S’s had the greatest impact on the 4th Quarter 2018, Showdown, Slowdown and Shutdown. The 4th Quarter began with markets near or at all time highs and the markets seemed to ignore the effects of the tariffs, political impasse and an almost Goldilocks outlook for Corporate earnings. The S&P 500, a broad measure of Large Cap Companies in the US, lost 6.4% for the year. Small and Mid Cap Companies faired even worse, the Russell 2000 lost 12.18%. European Equities, as measured by the Stoxx Europe 600, lost 13.24% and Chinese equities, as measured by the Shanghai Composite, lost 24.59%. (Source WSJ)
There were several factors that contributed to the almost 20% decline in the S&P 500 over the course of the 4th Quarter. It started with comments from Federal Reserve Chairperson Jay Powell, who implied that there were still several rate hikes in the Fed Funds rate before it reached a level the committee considered normal. This initiated a liquidation of assets as valuations were perceived to be elevated if rates were going higher. By the middle of November, the selling accelerated due to a decrease in Energy prices, an increase in volatility and a lack of liquidity because Hedge Funds and Mutual Funds were closing their book for the year and appeared to be unwilling to accept risk. This lack of liquidity was exasperated as the year came to a close. Liquidity vacuums appeared during the trading sessions as it appeared that humans sat on their hands and the computer driven algorithmic systems pushed the markets in a single direction. Add into the mix the tax loss selling, especially in the FAANG (Facebook Apple Amazon Netflix and Google), and the selling pressure increased. I must admit that in my years of exposure to the financial markets, I have rarely seen trading activity like that.
So where does that leave things heading into 2019 and what are my expectations. I think that the market has repriced valuations to a much more reasonable level. Corporate earnings should continue to increase, just not at the rate that was expected at the end of September. At that point in time, the S&P 500 was priced at about 21 times 2019 earnings. At the end of the year, that multiple had contracted to around 15. The Federal Reserve has begun to signal that the Fed Funds rate is much closer to neutral and that they should take a wait and see attitude on rate movement. I expect that oil prices should trade in a range around $53 per gallon. This price area would alleviate some of the concern that pressured the leveraged loan market last year. There was a concern in the junk bond and leveraged loan market that if oil prices were to go thru the year below $45 per gallon, Energy companies would have a difficult time servicing the debt that makes up a large portion of those asset classes.
I think that the Federal Reserve is doing a good job of responding to the volatility in the markets and to some signs of economic slowdown. Their data drive response, as opposed to the autopilot mode previously referenced, should curtail rate hikes and limit them to possible only one or two this year. As the economy continues to expand, albeit at a slower level than in 2018, and earning continue to grow, I would expect the equity market to recover some of the losses from last year.
There are, however, some cross currents that could hinder this expectation. Should the U.S. and Chinese trade wars not come to an amicable understanding, this would put pressure on Global Equities. As the U.S heads toward an election year in 2020, the political infighting between the parties could weigh on consumer optimism. If inflation, either thru prices or wages, rear its ugly head, then the Federal Reserve would have to increase rates at a faster rate than currently expected. There is Brexit, North Korea, Italian debt and a slowdown in the Chinese economy to also concern investors.
In general, I don’t think that the volatility and price action the market experienced last year will be repeated this year. I think that investors will need to be more active in their actions. While trying to manage around tax consequences, I think that a range bound market should cause more trading around the extremes. Cash finally offers a viable alternative to Fixed Income and can help buffer a portfolio’s volatility in trying times.
As always, if you have any questions or wish to discuss any of the above items please feel free to contact me.The opinions expressed herein are those of Riverbend Planning Group. The data and opinions are furnished for informational purposes only and should not be considered a solicitation for an investment decision. Although it is derived from sources believed to be accurate, Riverbend Planning Group makes no guarantee to the accuracy of the information
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