The market got hit hard in the fourth quarter, which was a bit unexpected considering how strong our US economy is right now. Many of the US equity markets experienced a bear market in the short three-month time frame. That is very unusual behavior. That said, the markets started rising after Christmas and look like we may be setting up for an extended run higher. There are several factors that caused the quick downdraft:
1. Investor Sentiment – In August and September I remember seeing, in just about every major news source, that we were in the longest bull market in the history of our country. I cannot refute what they were saying. But, the topic itself spooked investors and moved them into a “shoot first” mentality.
2. Interest Rates – At the first of October, the yield curve (2 year and 5 year) inverted. I won’t bore you with the economics class. But, when the yield curve inverts, it can signal a recession is coming. In this case, the yield curve went back to normal, so it was a false alarm.
3. Miscellaneous – This will probably sound a bit arbitrary, but the last 10-15 years has seen a huge ramp-up in electronic program trading. This is important because as the markets hit certain levels, the program trading kicks in. When trading kicks in, it can create “air pockets” in the markets that cause more drastic sell offs. The only good news is that it also works in reverse.
From a big-picture perspective, we feel very good about where the markets are, and we believe 2019 will be a good year for the economy and the markets. We went through a “shock” in the 4th quarter, but buyers are now coming back in. If the US economy remains strong, we feel the markets will follow suit.
As we pass through the final quarter of 2018, the U.S. equity market has seen markedly more volatility than in the prior year. A combination of rising interest rates, tariff threats and general European instability have led investors to take a more defensive posture in the latter half of 2018. This repositioning led to a near 10% drawdown from our September highs in the equity markets, and the 10-year treasury yield has risen nearly 30% in 2018. International markets have fared poorly this year, after a strong showing in 2017. Emerging markets, too, have come under pressure from rising interest rates, pushing a broad index of developing economies down 25% this year. Even taking into account the challenges of the global economy in 2018, U.S. corporate profits remain strong, and there are quite a few bright spots in the U.S. economic data. GDP growth has ticked up in 2018, and real wages are on the rise for the majority of the workforce—two indicators that have been stubbornly static for most of the recovery. November and December are historically strong months for the U.S. markets, and we believe that our current volatility will resolve itself into higher prices in the intermediate term.
As we reflect on this holiday season, we wish you and yours a very wonderful Thanksgiving, as well as, a Merry Christmas, and the very best of good health and prosperity for the New Year.