December 2018 Recap: There’s No Place to Hide

The headline on the front page of Saturday’s Wall Street Journal said it all, “Stocks Cap Worst Week Since 2008.” All three of the major indicators tumbled badly for the week and are likely to remain in negative territory for the year. The S&P 500 finally broke the lows set in February and March. Now it’s about 18% off the recent peak. U.S. small cap stocks and international stocks already went into a bear market (>20% off peak). Of the eight big asset classes — everything from bonds to U.S. and international stocks to commodities, not a single one of them is on track to post a return this year of more than 5%, a phenomenon last observed in 1972. So, you are looking like at another historically tough year. Nothing’s working, not large or small-cap stocks in the U.S., not international or emerging equities, not Treasuries, investment-grade bonds, commodities or real estate. Most of them are down, and the ones that are up are doing so by percentages in the low single-digits. That’s all but unique in history. Normally when something falls, something else gains. Amid the financial catastrophe of 2008, Treasuries rallied. In 1974, commodities were a bright spot. In 2002, it was REITs. In 2018, there’s nowhere to run.

As I noted in last month’s newsletter, there are a host of economic and political issues worrying the markets: interest rates, trade and tariffs, slowing growth in China, and “Brexit”. As of midnight Friday, you can add the partial federal government shutdown to that weighty list. The Trump Administration and Congress couldn’t agree on a funding plan even for the next couple of months. Presumably, the main sticking point was the President’s insistence on funding for a wall on the U.S. southern border. I doubt that the shutdown will have much impact on the economy so long as it is relatively short-lived. The markets were also disappointed in what they heard from Fed Chair Jerome Powell last Wednesday as the Fed’s FOMC Committee increased short-term interest rates by a quarter of one percent. The Committee evidently feels that two additional increases may be justified in 2019, even though they lowered their growth projection, and there is virtually no evidence of inflation in the economy.

The yield “spread” between short and long-term rates narrowed, putting additional pressure on the shares of banks and other financial institutions. The yield curve continued to flatten, worrying some analysts that it might become inverted, with short-term rates higher than long-term rates. Mortgage rates were virtually unchanged, though the housing sector continues to be weak. There’s a wide difference of opinion about where the U.S. economy is headed in the year ahead. Many economists and analysts believe that we’ll continue the strong performance we’ve had in 2018. They expect strong job growth to continue, wages to rise, and inflation to remain low. Others are less optimistic, worried that growth will not only slow, but that there’s a good chance of a recession just over the horizon. Which camp you’re in, if either, will color your reaction to last week’s announcement by the Federal Reserve that they would be increasing short-term interest rates, continuing on a path to “normalize” rates over the next year or two.

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