The fourth quarter of 2018 did not usher in the typical year-end rally that investors have come to expect in recent years. Global equity markets got off to a weak start, failed to recover, and ultimately plummeted, as weak business indicators collided with perceived governmental policy risks with respect to the Federal Reserve. Commodity markets also felt the pain of lower oil prices, and fears that a global economic slowdown was beginning to spread to the United States from abroad. By the end of the quarter, equity markets were caught in the grips of a cyclical bear market, and the only asset classes that yielded positive results were the traditional safe havens of bonds, cash, and gold. The quarter was brutal in the short-term due to volatility, and the full-year result was extremely unusual in that very few if any major asset classes offered any gains. But in the final days of the year, the market reversed course and began rallying.
As investors look forward to a new year, they’re faced with deciding whether it is wise to keep playing defense, or if it’s time to position for a new cyclical bull market that may have already begun.
Navigating A Cyclical Bear Market
We believe that stocks are currently caught in a shallow cyclical bear market, which will ultimately run its course this year, and set up investors for a great chance to purchase new investments at better values than have been afforded in quite some time. There’s no way to pinpoint exactly what tips the scales and ignites a sell-off, but the following are a few of the factors that contributed to markets reacting so violently during the recent fourth quarter.
Global Slowdown & Earnings Deceleration
Emotions can drive markets in the short-term, but major turns in the market often indicate the approach of a deterioration in the fundamental economic outlook. During the fourth quarter, evidence of a slowdown in the U.S. economy emerged as a wide swath of economic data began to reduce expectations. Earlier signs of slowing in housing and automobile sales finally leaked into manufacturing data, as well as other leading indicators of growth. To compound the weaker data, a sudden negative shift in bond valuation, higher volatility, and general weakness in business growth all contributed to a tightening in financial conditions. It is very likely that some of the market’s recent volatility was due to the global slowdown that appears to be spreading from the rest of the world to the U.S., along with evidence that corporate growth-rates had peaked. As companies reported their third quarter results, many of them had strong top line revenue and earnings growth, but were still punished in their stock price due to cautious growth forecasts. Corporations are citing global growth weakness, higher interest rates, and trade imbalances that continue to put negative pressure on growth, materials costs, and worldwide supply chains.
Federal Reserve Hiking into the Slowdown
The Federal Reserve has now hiked interest rates nine times in the latest market cycle (since 2008), and even though rates are still historically low, in the fourth quarter markets appeared to view continuing those rate hikes as a drag on growth. While the Fed has used a more gradual approach in raising rates this time, the fact that they have been tightening policy going into a global slowdown, and an ongoing trade war, appeared to tip the balance and turn a methodical tightening cycle into a choke point for markets. It’s also important to note that the central bank has also been reducing its balance sheet, and some analysts believe that this tightening effect was also a big factor in driving volatility during the fourth quarter. Lastly, due to rising short-term interest rates, the yield on short-term bonds had finally begun to beat some long-term stock returns, which may have encouraged some investors to start shifting out of stocks and into bonds during the quarter.