Contributed by: Angela Palacios, CFP®, AIF®
The 2018 wild ride!
We’d love to see you at our investment outlook event on Wednesday, February 27th from 11:30am-1pm for lunch and a full update on 2018 and the year ahead. You can register here.
How times have changed! As I write this, I often like to look back and see what I was thinking about last year at the same time. In the fourth quarter of 2017, we were talking about how low volatility had been for an extended period and that it was unlikely to continue. Unfortunately, we were right. In 2017, we had only eight sessions where the S&P 500 moved up or down more than 1% (versus the average which is 53 days in a given year since 1958)! In 2018 the number of days up or down more than 1% numbered closer to 60. While more than average, this is closer to average volatility than we had grown accustomed to. December is usually the least volatile month on record but this time registered more than it’s share of wild swing days for the year.
While we tend to love unlimited volatility on the upside, we greatly dislike downside volatility. According to behavioral finance experts Daniel Kahneman and Amos Tversky we hate the downside about twice as much as we love the upside or loss aversion.This is a concept that is embedded deeply within our investment strategy. We work to design portfolios that prevent you from making short-term decisions that contradict your long-term goals. Diversification is a key part of this process. Up until the last quarter of 2018, this was a strategy that had long been out of favor in this bull market for US Large companies. However, we started to see the benefits return. Below is a chart showing returns for 2018 broken down a few different ways and for several different benchmarks. The first section is Year-to-date (2018 full year) returns. For the year, the Barclays Aggregate was the clear winner as it was up slightly (blue bar). However, for the first three quarters of the year, it was the clear loser except for emerging markets (EM had been 2017’s, clear winner). It wasn’t until the last quarter, when volatility struck, that bonds were able to shine. The S&P 500 (US large companies) and Russell 2000 (US small companies) indexes were the exact opposite story. For the first three quarters of the year, the rally continued in a strong way with these markets up well over 10%. Once volatility struck, this meant these markets also had the farthest to fall and experienced the most downside in the last quarter of the year giving back all of their prior returns and then some for the year. It is an excellent reminder of the importance of diversification.
So what has this market so spooked?
The Federal Reserve raised rates for the fourth and final time of the year in December but also lowered its expectations for rates moving forward. Economic data is little changed, but The Fed’s reaction to the data shifted more dovish. The Fed is concerned that by raising too far, too fast they will invert the yield curve. They recognize it may be necessary to slow down. The yield curve hasn’t inverted quite yet (this is defined by the two-year being higher than the ten-year yield) but it has gotten much closer to this scenario. This is generally a good indicator that a recession is on the horizon but has not given this signal yet.
Democrats took control of the House on January 3rd as the government shutdown continued. President Trump and the Senate don’t seem to be willing to bend on their request for money for the border wall while Democrats just as strongly oppose. Ultimately, one side will have to bend to get the government fully back up and running and neither seem to have any incentive to make this happen yet. Markets generally aren’t rattled by government shutdowns unless they are prolonged. However, right now, everything seems to be rattling the markets. I don’t think you can specifically point to the government shut down as being a leading market concern but it is definitely on the scorecard. The longer it extends, the more it will erode consumer and investor confidence too.
China Trade Negotiations
Trade negotiations seem to be moving along, but this is a slow process. U.S. based companies are starting to report reduced sales into China, so we are beginning to see a direct effect to stock prices of domestic companies. There is talk of a hard deadline in these discussions of March 1st because if some negotiations have not come to a close by then, the U.S. will impose another round of tariffs on Chinese imports.
Brexit negotiations continue to stir up markets as it is not going as well as planned.Article 50 of the Lisbon Treaty was invoked on March 29, 2017.The UK has two years from this point to leave the European Union.So the deadline is fast approaching on March 29, 2019.Here is a helpful timeline of what is to come. Brexit is sure to cause some waves in the next few months.
To top off the global concerns, the Italians are making headlines again with debt concerns. And just as interest rates are rising here at home, they are starting to rise overseas. Finally yet importantly, the result of the Mueller investigations will come out soon. This could cause a temporary shakeup in markets depending on what their findings are.
It is interesting to note that these headlines have existed for much of the year. Up until early October, the US stock market seemed to brush them off in the wake of lower taxes. However, lower taxes could only distract for so long until these headlines started to spill over into investor sentiment, which became clear in October. It is important to remember to stay invested even through volatile events. Missing the biggest up days can be devastating on your long-term returns and, true-to-form, we experienced many of those for 2018 when the markets appeared at their bleakest moments in the fourth quarter. It is quite common that the largest up days occur during periods of downside volatility.
We are happy to discuss your portfolio with you at any time you may feel uncomfortable with market swings. We are monitoring your investments, making periodic changes when warranted and pro-actively rebalancing to take advantage of swings in the markets, both up and down.
We thank you for your continued trust. Have a wonderful 2019!
Angela Palacios, CFP®, AIF®
Director of Investments
Financial Advisor, RJFS
Angela Palacios, CFP®, AIF® is the Director of Investments at Center for Financial Planning, Inc.® Angela specializes in Investment and Macro economic research. She is a frequent contributor The Center blog.
Freedom Presentation by Nick Lacy, CFA, Chief Portfolio strategist.
The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered representative of the U.S. stock market. The Russell 2000 Index measures the performance of the 2,000 smallest companies in the Russell 3000 Index, which represent approximately 8% of the total market capitalization of the Russell 3000 Index. The MSCI EAFE (Europe, Australasia, and Far East) is a free float-adjusted market capitalization index that is designed to measure developed market equity performance, excluding the United States & Canada. The EAFE consists of the country indices of 22 developed nations.
The MSCI Emerging Markets is designed to measure equity market performance in 25 emerging market indices. The index's three largest industries are materials, energy, and banks. The Barclays US Aggregate Bond Index is a broad-based flagship benchmark that measures the investment grade, US dollar-denominated, fixed-rate taxable bond market.
Any opinions are those of Angela Palacios and not necessarily those of Raymond James. The foregoing information has been obtained from sources considered to be reliable, but we do not guarantee that it is accurate or complete. Expressions of opinion are as of this date and are subject to change without notice.
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