In many ways, 2018 was a paradox of a year. US equities and 10-year Treasuries both had negative returns, which almost never happens. Cash was the highest performing asset class for the year1. The United States posted some of the strongest economic growth numbers we’ve seen in years, and yet the yield curve inverted, supposedly warning of a recession. This string of improbable statistics came with a return to normalcy in some areas – namely volatility.
The fast and furious march upward in equity prices of the past few years lulled many investors to sleep. Investors seemed to have forgotten that prices move up and down, even during upward trends. Over the last 90 years, markets have experienced a decline of ten percent about once a year2. While we had a stretch of years recently where this did not occur, from a historical standpoint, it is the likely scenario.
Trade tensions between the United States and China continued to increase over the quarter, and investors began to worry this would contribute to a slowdown in global growth. Indeed, economic data out of China did begin to soften in the fourth quarter, and the World Bank lowered its global economic growth forecast for 2019 to 2.9%. Germany, the largest Eurozone economy, also contributed to global growth concerns as real GDP declined 0.2% in the third quarter and economic data surprised to the downside during the fourth quarter.
Employment data in the United States continued to come in strong. The Federal Reserve raised its benchmark rate during the quarter but also lowered its projected number of rate hikes in 2019 from three to two increases. Economists are now expecting only one rate hike for 2019, however, as inflation seems to be contained and economic growth is moderating.
To the surprise of many investors, emerging markets held up better in the risk-off environment during the fourth quarter. A weaker U.S. dollar in December, lower valuations, and company-specific news contributed to outperformance over domestic equities.
Energy fell sharply during the quarter, stemming from a decline in crude prices. Additional supply resulting from sanctions being lifted on Iran surprised the market. MLPs, which provide investment exposure to pipelines that transport oil, gas, and other petroleum products, retreated in the fourth quarter amidst souring energy-related investor sentiment and several corporate actions taking place in the space. A combination of tax loss harvesting, corporate transactions and risk aversion negatively affected the asset class. Despite the equity market reaction, pipeline volumes, cash flow growth and balance sheets continue to strengthen in the space.
While cash was the highest performing asset for the year, it has been among the worst performing asset classes each year over the last ten – and on an annualized basis, it still is the worst performing asset class over the last ten years outside commodities. In other words, returns to cash over the long-term are still unattractive. We expect to remain in an environment of increased volatility as investors are looking for any cracks in the market. To reiterate, this is not unusual. The unusual rise in asset prices and fall in volatility, particularly in 2017, caused some investors to move into portfolios that may be more aggressive than their true risk tolerance would indicate.
Now is a good time to reach out to your relationship manager to review your appetite and ability to take risk and make sure that your portfolio is in line.
1 as measured by the 90 Day T-bill, returned 1.9%.
2 S&P 500 Index, 1928-2017