In a year that began with the manager of one of the world’s largest hedge funds declaring “if you’re holding cash, you’re going to feel pretty stupid,” cash turned out to be one of the few asset classes to post a positive return. In fact, a recent article ran with the headline “Why 2018 has been the worst year ever, according to this one metric.” What was the one metric? In 2018, approximately 90% of the asset classes tracked by Deutsche Bank finished the year in negative territory. This was the highest percentage going back to 1901. A recent article by CNBC entitled, “Nothing worked for investors this year – nearly every major asset class is in the red for 2018” also highlighted the unfavorable market conditions. To add insult to injury, the much anticipated “Santa Claus Rally” never really materialized. In fact, the Dow Jones Industrial Average and the Standard and Poor’s 500 index posted their worst December since 1931, with the Nasdaq posting its worst December on record. Not exactly a joyous way to ring in the new year. But why? Why did the market fall so violently to close the year and were there any clues that risk was rising?
While there is rarely just “one” catalyst for a market selloff, a factor that may have contributed to the decline was fear about a hawkish Federal Reserve (Fed) on a “pre-set” path for further interest rate increases in an environment of slowing global growth. The Fed raised rates four times in 2018 after raising them three times in 2017. In early October, Fed Chairman Jerome Powell told a Washington audience that rates may have to move beyond neutral and that “we are a long way from neutral at this point, probably.” The message received by the financial markets was several more interest rate increases were in store if the Fed believes we are still a long way from the “neutral” interest rate, meaning not too tight nor too lax. Given this backdrop, investors became increasingly nervous as the Fed pushed through another rate increase in late December in spite of several reports showing global economic growth slowing.
Prior to this selloff, there were observable clues the market may not have been quite as strong as many believed. Referring back to our 2nd quarter 2018 commentary published on July 16, 2018, we highlighted what we believed to be five potential signs of late stage activity within the stock market.
- A flattening of the yield curve
- The underperformance of the financial sector
- A narrowing of the leadership within the stock market
- Lax credit conditions
- Tightening of monetary conditions
As stated at the time this was written, none of these signs in and of themselves meant an immediate end to the bull market in stocks in our opinion. Rather, they were pieces of information that informed the level of risk we were comfortable holding within our model portfolios. We concluded with the mantra, “proceed with caution.”
So where does this leave us as we enter 2019? First, many U.S. and foreign stocks have fallen 20% or more in the past few months. While this has not been fun, it could mean there is less risk in the market as compared to the start of the 4th quarter of 2018. Not no risk, but less risk in our opinion. The question remains whether this is the start of a larger fall in stock prices or a rapid repricing of the market to more reasonable levels. The answer to this question will likely rest on whether the U.S. economy falls into a recession. Given these growing concerns, Fed Chairman Powell came out in early January and reassured the markets by saying mild inflation would give the central bank greater flexibility to set policy in the year ahead and that the Fed wasn’t on a “pre-set” path to push its benchmark rate higher. He added, “We will be prepared to adjust policy quickly and flexibly and use all of our tools to support the economy should that be appropriate.” The stock market responded positively by surging more than 3% in a week.
Unwinding the extreme monetary policy put in place by the Fed to fight the Great Financial Crisis will not be easy in our opinion, especially given the enormous debt amassed at both the corporate and government level over the last ten years. With all these uncertainties, we remain resolute in focusing on those things which we believe we can control. Namely, managing the risk in our portfolios through asset allocation construction and careful security selection. If prices continue to fall and the risk/reward for owning stocks improves, we intend to increase the risk weightings in our model portfolios. We will leave the prediction game, which is so common at this time of the year, to others. As Lao Tzu said, “Those who have knowledge, don’t predict. Those who predict, don’t have knowledge.”
As always, we remain committed to helping you achieve your unique financial goals.
The information contained in this commentary has been provided by PYA Waltman Capital, LLC for general information purposes only and has been obtained from sources believed to be reliable, but is not guaranteed. The information shall not constitute investment advice or an offer or recommendation to buy or sell any security, commodity or services. The products and services described in this commentary may not be available to, or suitable for, all investors.
Past performance does not guarantee future results. Market conditions can vary widely over time and can result in a loss of portfolio value.
The NYSE Composite Index is a float-adjusted market-capitalization weighted index which includes all common stocks listed on the NYSE, including ADRs, REITs and tracking stocks and listings of foreign companies. The index was recalculated to reflect a base value of 5,000 as of December 31, 2002.
The S&P 500 measures the performance of the 500 leading companies in leading industries of the U.S. economy, capturing 75% of U.S. equities.
Russell 2000 Index measures the performance of the 2,000 smallest companies in the Russell 3000 Index representing approximately 8% of total market capitalization of the Russell 3000.
MSCI All Country World Index is a market capitalization weighted index designed to provide a broad measure of equity-market performance throughout the world. The MSCI ACWI is maintained by Morgan Stanley and is comprised of stocks from both developed and emerging markets.
The MSCI Emerging Markets Index is a free float adjusted market capitalization index that is designed to measure equity market performance in the global emerging markets.
The Barclays Capital Aggregate Bond Index comprises government securities, mortgage-backed securities, asset-backed securities and corporate securities to simulate the universe of bonds in the market. The maturity of the bonds in the index is over one year.
The volatility (beta) of the portfolio may be greater or less than the benchmark. It is not possible to invest directly in an index/indices.
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