2018 Year-end Market Commentary

2018 proved to be a curious year for financial markets. At the end of the third quarter, US stocks were firmly on track for their tenth consecutive year of gains, up +10.6% on the year through Q3 as measured by the Russell 3000. Then, we saw a shift as US equities fell -14.3% during Q4, including a drop of -9.3% in December, marking the worst closing month to a year since 1931. As a result, US stocks ended 2018 down -5.2%, a modest loss on the whole, though still the worst year since 2008 for domestic investors.

Most other major asset classes did not fare much better, as profits were largely hard to come by during the year. International stocks fell by -11.5% during Q4 to end the year down -14.2% per the MSCI ACWI ex-US. After lagging most of the year, bonds caught a bid as investors flocked to safety during a tumultuous December, with the Barclays Aggregate Bond index gaining +1.8% on the month to erase a year’s worth of losses and end 2018 flat. In a similar vein, gold was the best performing major asset class during Q4, gaining +7.7% on the quarter after being cast aside during much of the bull run in equities, resulting in full-year performance of -0.9%. Real estate, high yield fixed income, MLPs, hedge funds, and convertibles/preferred all suffered negative returns in a year that stymied investors across the board. The star performer during 2018: the long-forgotten asset called “Cash”, which gained +1.8% as measured by the S&P 0-3 Month T-Bill index, as the Federal Reserve continued in its effort to normalize short-term interest rates.

Speaking of the Fed, looking forward to 2019, rate policy will remain in focus alongside global trade policy and the path of corporate earnings. As always, we aim to filter the news and noise through the lens of our “Three Dials” framework. Below is a primer on where each of our primary indicators stand to start the year:

1. Market Sentiment and Momentum: Negative (downgraded from “Neutral” last month)

As alluded to above, investors jitters led to declining stock prices during the end of 2018. We expect volatility to remain elevated in the near future as market participants jockey for position and await further clarity on Fed policy and other global geopolitical developments. As a result, our Momentum/Sentiment Dial is showing a “Negative” reading for the time being

2. Valuation: Negative (unchanged from last month)

We have long viewed valuations as stretched compared to historical norms, and perhaps part of the steep decline in stock prices recently is due to the markets being priced for “perfection” in a far from perfect investment landscape. While valuations have become more reasonable thanks to the recent decline in prices, we still view equities as expensive, and as such our Valuation Dial remains in a “Negative” position.

3. Economic Fundamentals: Positive (unchanged from last month)

One of the bright spots amidst recent market turmoil is that the real underlying economy appears to be on track to retain its steady growth trajectory into 2019. Year-over-year GDP growth in the US should remain in the 2-3% real range, not far below the long-term average. While we are certainly in the later stages of this economic expansion, leading economic indicators are strong enough such that our Fundamental Dial shows a “Positive” reading.

On balance, we are slightly underweight “risk assets” as we wait to see how this recent equity market volatility plays out. As always, we are monitoring new developments as they arise and will communicate any changes accordingly. A key tenant to successful investing is to have a well thought out strategy and stick to it when things looks scary, and we are confident that our Three Dials approach is built to withstand even the most trying of market conditions.