“Life can only be understood backwards, but it must be lived forwards.”
Words of wisdom from the Danish philosopher, Soren Kierkegaard. Ditto the markets. So now that we’re closing in on the final days of 2018, we can start to try and make some sense of the year almost past.
To start: never a dull moment. Markets have grappled with tariffs and a potential trade war with China, rising interest rates, big swings in the price of oil, and political uncertainty in the run-up to the mid-term elections. But for all that, underlying economic growth remained strong. In spite of this, multiple asset classes have seen negative returns, including gold, bonds, and oil—an unusual circumstance. Stocks, as measured by the S&P 500, have been in and out of positive territory, most recently down -4.77% through December 18, 2018. Investors can be forgiven for feeling a little whipsawed.
One point that has been driven home yet again: the difficulty of making accurate, short-term market forecasts. The dollar has bounced around, with the Wall Street Journal Dollar Index starting the year at $85.62, declining to $83.53 in April, and then heading up, getting as high as $91.10 in November before dropping again. The Fed looked likely to continue its cycle of tightening well into next year, until it didn’t. Fed Chair Powell set off a serious rally when he indicated in a speech that the Fed’s benchmark rate of 2.0-2.25% was “just below” neutral, suggesting fewer rate increases for 2019 than investors had been expecting.
FAANG stocks, once everybody’s darlings, experienced a bear market, down over 20%. The S&P 500 went through two corrections—a decline of 10% or more from the highs—in the year. While corrections are common—since 1950 there have been 37, according to Yardeni Research, or, on average one about every 22 months—two in one year is more unusual.
Looking back, what can we conclude from all this? One point certainly is the persistence of mean reversion: periods of low volatility will be followed by the return of volatility; currencies will move up and down in relation to one another and to the dollar; the politics of the day will cause short-term dislocations but longer term, fundamentals matter more; and markets will reset based on underlying earnings and economic growth.
Related: The Market’s Wild Ride
How and when all this will happen is not entirely knowable—a challenge that again serves to highlight basic principles. For example, volatility is not the same as permanent loss, but managing volatility can help individuals stay committed to an investment program and help improve long-term return potential. Market timing is hard, and counter-productive for most people. The Fed still matters. As of this writing, the economy is still growing—the December 18th GDPNow forecast from the Federal Reserve Bank of Atlanta was 2.9%—and many fundamentals like the unemployment rate and consumer spending are supportive of continued expansion.
Ten years into the economic recovery and the March 2009 market bottom, investors are understandably concerned about what the New Year will bring. Looking back 12 months from now, it will all be clear. In the meantime, it’s worth keeping in mind that this year and next, tools like liquid alternatives and 50%-hedged international equity funds will continue to provide an opportunity to stay invested while seeking to protect against the inevitable fluctuations in prices.
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