For the year 2018, stock prices as measured by the S&P 500 fell 4.4%. The late-year selling frenzy came as quite a disappointment to many. Through the end of September 2018, stock prices were up 10.6%. Then, October brought a wave of selling, and prices fell 6.9%. After an attempt to stabilize in November, the bottom dropped out in December, and prices fell another 9.2%.
Since the November 2016 election, stock investors had been quite content. The market went on a run of 15 straight months with positive returns. Then trouble began to stir in early 2018 when prices fell in February and March. Though prices recovered through mid-2018, the year-end disruption led to panicky selling and wiped out cumulative gains for the S&P 500 dating back to October 2017. Investors are now anxiously wondering what’s to come.
We experienced unnerving volatility in 2008 when stocks fell relentlessly in reaction to the financial crisis and the ensuing recession. However, the year was bookended by a 5.5% return in 2007 and a whopping 26.5% return in 2009. Prices recovered quickly benefiting those that remained invested. The height of the dot-com bubble in 2000 sent prices down 9.1% that year and then a further 11.9% and a painful 22.1% in the two ensuing years. At present time, there is no evidence of another financial crisis (a one-year market debacle) or a dot-com bust (a multi-year market debacle) but rather a slowing of growth (which is normal for markets in later stages of the business cycle) and continuing political turmoil.
In my view, there are three things to monitor. First, the backdrop: the trade war with China, the government shutdown, the ongoing Brexit talks, and the realization that political gridlock seems likely to prevail. Second, the Federal Reserve has been raising interest rates, and the old axiom “don’t fight the Fed” clearly remains alive and well. Finally, earnings growth crested dramatically last year and is now beginning to decelerate.
Investing can lead to heightened emotions, and I think it’s becoming more difficult for people to confront the random and reckless commentary from Washington. My sense is that investors are at their limit, feeling that more damage is being done than their prior optimism can counter.
My take on the Federal Reserve is that it views the US economy as generally healthy, though growth is slowing. The Fed appears to be shifting away from its more hawkish position and is messaging more flexibility. Importantly, it has raised rates nine times since near-zero rates three years ago, and that was the responsible thing to do. It does not appear that current policy, with the Fed Funds rate in the 2.25% range, is overly restrictive.
The earnings outlook for 2019 is tempering. Earlier in 2018, consensus was for $178 per share or 10% growth for 2019. According to FactSet Research, analysts now have lowered their earnings estimates for the S&P 500 for the fourth quarter by 3.8%, which has led investors to lower their return assumptions.
Some patience with and confidence in the long-term tendency of the stock market to soldier on is important at this juncture. I believe that the Federal Reserve will take the correct actions and does not need to be brow beaten. While the market has re-rated and P/E ratios have fallen 25% from their highs, stocks are much more attractively priced than they were three months ago.
Stocks are the primary sources of return for most investors. The numbers bear out, as stocks have generated positive returns 75% of the time over the last 40 years. When the markets are in flux, we advocate prudent re-balancing between stocks, bonds, and cash. Since the second bout of volatility kicked up in late September, we have held above-normal levels of cash. Now, our effort is to put cash to work in quality, stable growth companies selling at reasonable prices. Our goal is to remain fluid as the market looks to orient itself between high growth and dividend-paying value companies.
As always, we are available for a call or meeting if you would like to discuss whether some changes to your asset allocation are in order.
Bruce Hotaling, CFA