Year End Reflection: 2018
Recent volatility has given us even more to think about during what is already a reflective time. The question we hear in the media (more than from our clients), is what to do…buy, sell, run, or hide?
Over the 12 months through December 24, 2018, the most extreme drawdown in the US equity market has been just under 20%, while for Non-US equities, the drawdown has been 21.6%. This recent downdraft has brought year to date numbers for US and Non US equities firmly into negative territory for 2018.
Volatility such as we have seen in the 4th quarter is no reason in itself to make wholesale changes to a well-planned investment strategy. Market corrections (declines of over 10%) and even bear markets (declines of over 20%) are a normal, although potentially unnerving, part of equity investing. Thus, our approach continues to focus on practical and measured recommendations, always within the context of a well-diversified and high quality long-term allocation. We believe that accurately calling market tops and bottoms (both of which are necessary for successful market timing) is not only nearly impossible, but also dangerous to long-term return potential. Yesterday’s significant gain is good case in point for those ringing the bell to sell.
While we anticipated more volatility in 2018 than in previous years, this year has undoubtedly been more of a roller-coaster than we expected, and the last few months of equity market declines seem years apart from the optimism so many felt about the markets and the economy just 12 months ago. After a blistering start to the equity markets in January, multiple concerns have crept into the spotlight. Early in the year, conditions appeared too hot and many were concerned that higher inflation, tighter Fed policy, and higher interest rates could suffocate the economy. Then (and still) the escalation of tariff actions have hurt the outlook for global trade and thus in turn, global economic growth. Adding fuel to the fire, the market spent the last few months wrestling with the reality that recent exceptionally robust global economic activity and earnings growth cannot be replicated year after year. Finally, the lack of stability in political and policy expectations at home and abroad has heightened real and perceived risk. The current partial US government shutdown is just one recent example among many.
All of these concerns remain valid and are important to consider within the broader context of a mature business cycle. Still, our near-term view heading into 2019 is consistent with our October update and more cautiously optimistic than recent volatility would imply. Having reflected a great deal upon the data, our views on interest rates and trade remain unchanged. We think rates have only limited room to rise while the unresolved trade/tariff situation between the US and China has potential to very modestly dent growth and add some pressure to inflation. Upward interest rate pressures from the US Federal Reserve running off its balance sheet and from the growing US budget deficit should be offset partially by modest growth and inflation potential as well as greater demand for yield among fixed income buyers. Trade, if unresolved, will likely be a headwind to growth and tailwind to inflation, but is not expected to cause the next recession. Trade also has the potential to change for better or for worse at any moment; as such, it would be very difficult to take a strong portfolio position in response to current trade uncertainty. The best position remains broad diversification across companies, sectors, and regions.
The fundamentals continue to point towards more modest, yet positive, growth and earnings. Given that the equity markets are a forward-looking mechanism, we expect that equity markets will continue struggling with this concept of positive but lower growth and earnings. When one adds the move behavioral component of political tensions and uncertainties, we expect the margin for error for companies and for the economy as a whole likely will remain narrow, with punishment for missing expectations or damaging confidence to be severe.
Given this environment, we continue to focus on building portfolios with differentiated sources of risk and return, high quality underlying holdings with justified return expectations relative to risk, and clearly marked sources of liquidity and diversification. As we note on a regular basis, we do not recommend trading or timing the current volatility unless your objectives or time horizon have materially changed.
As the holiday season comes to a close, we hope that you and your loved ones have a wonderful time to relax, reflect, and recharge. We look forward to sharing our annual market outlook with you in the coming weeks and wish you all a Happy New Year.
