Equity Overview

Stocks suffered their worst December since the 1930’s, as a perfect storm of negative events battered the market:  the unresolved trade war with China, the partial government shutdown, fears of recession in the U.S., and signs of a worldwide economic slowdown.

Value stocks and growth stocks were buffeted about equally, but large cap stocks marginally outperformed small caps.  Volatility returned with a vengeance, as the S&P 500 gained or lost more than 2% on 8 of 19 trading days.

On a hopeful note, the December drop in stock prices caused the forward price earnings ratio to decline to about 15x, well below the 5-year average of 16.4x.  This suggests that markets may have overreacted and that a rebound may be in order.

Macro Overview

Notwithstanding a promising start, low unemployment, strong corporate profits, and a massive tax cut, 2018 ended as the worst year for stock performance since the financial crisis of 2008.

What happened?

Among the factors has been our trade war with China, which injected uncertainty into the economies of both countries.  While the impact has been muted in the U.S., as the year progressed concerns grew that if the dispute remained unresolved, consequences would reverberate throughout the domestic economy.  And the impact in China is already notable, as the most recent data indicates that its economy is growing at its slowest rate in almost 10 years.  Signs that the world’s second-largest economy is faltering have become worrisome.

Moreover, economic anxiety has not been limited to China and the U.S.  Stock market indices in every meaningful economy worldwide finished down in 2018, at levels ranging from 5.6% in Brazil to 43.5% in Turkey.  This included Japan and Germany (the world’s third and fourth largest economies) where growth in both countries contracted in the third quarter, and where market indices were down for the year by 15.4% and 23.2%, respectively.

Equally significant has been the Federal Reserve, which raised interest rates four times in 2018.  While each of the increases was modest and well-telegraphed, investors became increasingly fearful that the cumulative result of the increases, coupled with potential additional hikes in 2019, could stifle economic growth in the U.S.

Finally, speaking of uncertainty, which markets abhor, the political situation in the U.S. is as unsettling as it has been in decades.  Large sections of the federal government are shut down with no apparent endgame in sight.  The philosophical gap between Democrats and Republicans continues to widen.  Prospects for meaningful legislation of any kind seem remote.  Government by tweet is not helping.

But we recall that, after the meltdown in 2008, the world teetered on the brink of catastrophe.  However, the market rebounded and a ten year bull market began.  We attribute this in no small measure to the resilience of our political and economic systems.  While circumstances may appear discouraging at the moment, history suggests that creative solutions will be found.