Challenging Years - A Look Back and Ahead

BY: Mark Drachenberg

If you are a fan of the mundane things in life, then 2018 was not your kind of investment year.  On the other hand, if you thrive on the wild side, then the markets did their best to take you along on an adventure.  A challenging year to say the least.  The same might be said about 2019 once it is in the books. 

While this is being written prior to the end of the year, it isn’t likely that the rest of 2018 will deviate much from the path that we have already walked.  Volatility, markets seesawing back and forth, tweet storms, trade wars, economic growth, consumer confidence, low unemployment and on and on.  Pick your topic and we could write volumes about it.  The year unfolded with a bang as the markets rocketed higher in January.  Then the floor dropped out as we experienced our first correction (a stock market drop of more than 10%) in two years when we normally average about one a year.  Things stabilized as economic growth numbers improved solidly throughout the year with GDP topping three percent in the second and third quarters.  With unemployment hovering around 4%, inflation low, corporate earnings growing solidly, all seemed well with the world as we entered fall.  The term “fall” seems to be the right one – at least as far as 2018 went.  The markets tumbled in October once again resulting in most major indices giving back all of their returns for the year and perhaps much more as in the case of the EAFE (international stocks).  Tech stocks like Amazon and Google and Apple led the markets lower and volatility higher.  Then all eyes focused on November and the election if for no other reason than to divert attention from the awful month October was.  The election came and went and as expected a split government resulted which calmed the markets a bit as it likely meant no massive changes in policy.  In fact, by the end of November, the markets had one of their best weeks in a couple decades, and hopes for a Santa Claus rally were springing forth.  Then, trade and tariffs dominated the news - especially related to China.  The G-20 leaders met in Buenos Aires in late November and it appeared some work had been done on the trade issue between the U.S. and China.  The following Monday, the markets roared higher by over 600 points only to be hit with a tweet storm on Tuesday causing the markets to drop over 800 that day.  The markets have since continued their wild ride with no end in sight.  One other note about 2018…we lost one of the great leaders of our country when former President George H.W. Bush died on November 30th.

Turning to 2019:  This year will likely be a challenging year for investors as well due to several factors.  Economic growth as measured by GDP will likely slow to between 2% and 2.5%.  This may be perceived as a slow-down by many and may cause heightened volatility even though the rate of growth would still be at the average level over the past decade.  Inflation will likely be range bound around the Fed’s target of 2% although a spike in oil or wages could move the needle higher.  Unemployment will continue to fall towards 3.5% and possibly lower (the Madison area will be even lower) but may tick back up towards 4% by the end of the year.  The Fed is likely to increase rates 2-3 times and will continue to reduce its balance sheet each month.  They may pause at some point during the year and it wouldn’t be a shock to see that happen earlier than otherwise expected should economic activity slow.  Should the Fed be more aggressive and raise rates 3-4 times the markets would likely view that as a negative.  Industrial and consumer confidence will soften from the very high levels seen in 2018 and this may add to volatility fears but unless the economy slows more or faster than expected these numbers likely won’t drop off dramatically.  Finally, returns on equities may end up slightly below historical averages in the mid-single digits with international equities likely outperforming domestic equities based on current valuations.  The fixed income markets may add some value due to higher yields but still only be in the low-single digits on a total return basis as yields offset principal declines.  Cash will continue to climb throughout the year and will become a viable alternative especially for conservative investors.  Putting it all together and a balanced portfolio may struggle to reach a 5% total return for the year. 

The dreaded “R” word seems to be on people’s lips more often these days but, at this point, there just isn’t a lot of hard evidence that a recession will hit this year.  One sign that may be pointing in that direction, however, is the yield curve.  A normal yield curve implies lower rates the closer you are to maturity and higher rates the further out you go.  An inverted curve, on the other hand, shows short-term rates higher than longer-term rates in a reasonably sure sign that investors feel the economy is due for a slow-down or retraction.  We have been toying with an inverted curve for a month or so and historically that is a reasonably, but certainly not perfect, indicator that a recession is on its way.  I wouldn’t read too much into that in the absence of other data but it is worth watching.  Having said that, an inverted curve may offer opportunities in cash and other short-term fixed income securities as yields tick up.

These are certainly challenging times from an investment and investor standpoint.  Potential threats seem to pop up on a daily basis but so do opportunities.  Since we do not advocate for market timing, we would advise against making wholesale moves at this point.  It is a great time, however, to review your investment strategy or at least develop one.  After doing so, review your current portfolio or work with an advisor to do so and then make appropriate adjustments. 

Lastly, turn off CNBC or Fox Business and enjoy life! 

Happy New Year!

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