Fourth Quarter 2018 - The Year When Nothing Worked

2018 will be broadly remembered as a year when nothing worked and daily stock market volatility spiked. This contrasted with 2017 where seemingly everything pushed higher, and volatility was low. But in 2018, nearly every single asset class and all but one major stock market index (Brazil) around the globe posted negative returns.

International markets sagged earlier in the year and U.S. equity markets finally felt the pain in the fourth quarter. After hitting an all-time high on Sept. 20, 2018 and then coming within a whisker of that record intraday on Oct. 3, 2018; the S&P 500 began a sharp move lower that eventually reached a 19.4 percent total decline on Christmas Eve. The index then reversed course and staged a stunning 5 percent rally on the day after Christmas and inched higher, finishing the quarter with a 13.52 percent loss. For the entirety of 2018, the index fell 4.4 percent. But that masked the widespread damage as only 3 of the 11 sectors produced positive returns, with cumulatively five down more than 12.5 percent. U.S. mid-cap and small-cap stocks fared worse, falling 11.1 and 8.5 percent respectively. This downward move was swift, and it was the 10th worst quarterly return for the S&P 500 dating back to 1950.

Interestingly, in all but one of the other nine downturns, investors who held steady experienced positive outcomes one year later. And for those who believe this market downturn is a good forecaster of a looming recession — in all but one, they occurred during or after the end of recessions, not before.

We believe this downturn is largely self-induced and not fueled purely by economic forces. Indeed, the U.S.-China trade war, Brexit uncertainty, the Italian-European Union budget stand-off, the U.S. government shutdown and the Federal Reserve’s confusing monetary policy messaging have provided ample opportunity for humans — and more likely computers — to react to potential happenings. “Fix” these and you likely fix the markets.

A Brief Review of Our 2018 Outlook

We entered 2018 expressing our belief that monetary policy normalization and rising inflation would lead to a bond market and subsequently equity market correction in 2018. While it’s been lost in the shuffle, keep in mind that the S&P 500 fell 10 percent at the beginning of the year — longer-dated U.S. Treasuries spiked, and stock markets shuddered due to Federal Reserve rate hike fears. These fears eventually dissipated, and markets moved higher through the summer only to once again be spooked by a rise in U.S. Treasuries early this fall.