Volatility was truly back in 2018. The year began well with the S&P 500 gaining over 5% in January, but then through mid-February it quickly suffered a 10% correction. From there the U.S. stock market again rallied and by the end of the third quarter the S&P 500 was up over 10%. The fourth quarter was a particularly tumultuous one for stocks with the S&P 500 and Dow posting losses of 13.5% and 11.3%, their worst losses since 2011. The NASDAQ plunged 17.5%, its worst quarterly decline since 2008. This was the worst December for the U.S. stock markets since 1931.
The final tallies for 2018: S&P 500 -4.4%; Dow -3.5%; NASDAQ -2.8%. International markets performed even more poorly: MSCI ex USA (all world ex US) -13.8%; MSCI EM (Emerging Markets) -14.5%. The good news is that stock markets have only posted consecutive negative returns on two occasions since the end of World War II (1973-74 and 2000-2002), so the odds look good for a positive year for stocks in 2019.
There was a confluence of issues that triggered the fourth quarter stock sell-off. Topping the list of concerns include rising interest rates, the trade war with China, the strong dollar, flattening yield curve and the government shutdown. It was feared that these issues could cause a significant economic slowdown or even a recession with corporate profits shrinking and stocks experiencing a very significant decline.
It does appear that economic growth is likely to slow this year to around 2% from the roughly 4% rate of 2018, but it does not appear likely that growth will go negative. Many of the previously mentioned concerns are already showing signs of reversing. Interest rates looked to have peaked for this cycle as the yield on the 10-year Treasury Bond has fallen by over half of 1% and the Federal Reserve has indicated a more benign stance on further Fed Funds rate increases.
The peak in interest rates brings with it the likely peak in the dollar. A lower dollar makes U.S. goods more competitive and stimulates economic growth in this country.
Energy prices have fallen considerably over the last 3 months – WTI crude oil has fallen from over $70 per barrel to under $50 per barrel. This gives consumers extra disposable income to keep the economy running.
Unemployment is at 3.9%. This continues to be a 50-year low level and is a sign of economic strength. The government shutdown has lasted weeks, but it will end sooner than the rhetoric would imply. China and the administration are talking, hopefully progress is being made to ease trade tensions.
If the U.S. economy does not go into recession and we do get modest economic growth then corporate profits should be higher in 2019. In fact, consensus estimates for earnings of the S&P 500 should increase from $163 to $174, up 6.75%. The S&P 500 ending 2018 at 2,507 which works out to 14.4x 2019 earnings and is slightly below the 30-year average of 15x. Inflation and interest rates are below their 30-year averages, in this context stocks are now cheap. The fundamental backdrop for investing in stocks is currently favorable and 2019 could be a good one for stock returns.
Wishing everyone a very Happy, Healthy & Prosperous New Year!
Michael Kane
