2018 ended with tremendous fear in financial markets. The domestic stock market delivered its worst month-of-December performance since the Great Depression (1931): S&P 500 down 9.03% on a total return basis. Virtually every asset class, except cash, ended the year in the red.
Normally, with a flight-to-quality from risk assets you have strong performance in high-quality bonds. However, with the Federal Reserve Bank “tightening” (raising short-term interest rates) aggressively, most bond categories had negative total returns for 2018 as well.
Why did the markets fall? Since WWII the Fed has had 14 tightening cycles, including this one, and 10 of the 13 in the books ended in recession. The trifecta of the Fed’s December rate hike, threats of the federal government shutdown and China trade dispute spurred talk of an imminent economic growth slowdown, if not something worse.
Soon, thereafter, Chairman Powell indicated that the Fed would pause tightening and would also curtail quantitative tightening or systematic selling of treasuries and mortgaged-backed- securities back to the private sector during 2019. (Note: Though the Fed is an independent government agency, it is possible that Chairman Jerome Powell’s decision to pause tightening was influenced by pressure from the President.)
At year end the S&P 500 was trading at under 15 times 2019 earnings estimates, making the stock market cheaper than at any time since 2013. With the Fed on hold, and the recognition that fears of imminent recession were overblown, the markets troughed. From the end of December through the end of February the S&P 500 rallied over 11%. The bond markets rallied as well, discounting the likelihood of interest easing before tightening.
Fast Forward
Fourth quarter domestic corporate earnings came in fairly positive, though the percentage of companies reporting actual earnings above estimates was below the five-year average. The latest domestic economic growth numbers exceeded expectations, in spite of weather and government shutdown effects. However, corporate earnings guidance for the remainder of the year has been overall poor. Some analysts have called the current environment an “earnings recession.”
The equity bull market trend remains intact, though bruised by 4th quarter results. Interest rates could stay where they are, if not move lower – a scenario that bodes well for bonds. In summary, we could see more of a “Goldilocks” (not too hot, not too cold) investment climate for the foreseeable future.
We are using this recent stock market rally, one of the steepest and fastest in decades, as an opportunity to rebalance (“sell high, buy low”) across stock market sectors and geographies.
We are here to serve you. Please call us at 318-675-0826 if you have any questions.
Sincerely,
Jack E. Ditt, Jr. William L. McCollum
