Market participants were reminded what investing in stocks is all about last quarter. Volatility!
The fourth quarter of 2018 proved to be very tumultuous for markets both domestically and internationally. The S&P 500 reached a record high near the end of September, but had a weak October and ultimately declined at the end of the year despite a late November rally. It dropped 13.52% for the quarter and 4.37% on the year. Concerns about corporate profits, persistent geopolitical concerns, and worries about the effects of trade disputes on global growth were a few of the culprits for the market weakness. International markets, both developed and emerging, held up better than domestic markets during the fourth quarter. Annually, however, international markets had a weaker year in 2018. The MSCI EAFE, a widely-followed international benchmark, was down 12.49% this quarter and down 13.32% year-to-date.
Long-term interest rates declined during the quarter as a result of stock market turmoil. The ten-year Treasury yield topped 3% earlier in the year, and popped above 3.2% at one point during the quarter. However, following a flight to quality, the ten-year yield dropped back to 2.69% at year end. Short-term rates continued to inch higher following rate increases from the Federal Reserve Open Market Committee (FOMC), and another rate hike occurred, as expected, in December. The FOMC indicated that the rate of increases may moderate in 2019 following the December meeting.
We believe the Fed will continue a moderate pace of interest rate increases and trade negotiations will not escalate into a trade war. However, we actively reduced risk in portfolios early in the year, returning to a neutral position between stocks and bonds. We continue to believe inflation—not market volatility—is the prominent risk to investors, and that stocks represent the best opportunity to build wealth over the long-term in order to achieve investment goals. With that in mind, we should spend a minute discussing market turbulence in the context of a long-term view.
Relative to cash and fixed income assets, market volatility is the price that an equity investor pays for higher returns over time. However, the most recent declines may have tested many investors’ resolve. The most recent quarter reminded us that market turbulence is normal despite the reprieve we’ve experienced in more recent years. 2017 was certainly an anomaly in terms of market volatility. In fact, for the S&P 500, there wasn’t a month that ended in a decline during 2017. Historically, this has never happened before. Normal markets can expect monthly and quarterly declines from time to time and the occasional 10% and 20% decline, as well. Declines of 10% have occurred on average once per year and 20% declines (a bear market) occur every seven or eight years. They are impossible to predict but have always been temporary unless they are made permanent – by selling and going to cash. And because they are randomly occurring, staying invested, rather than trying to time the market, is the wisest course of action.
It is important to keep the long-term in mind, especially in choppy market conditions. Bear markets do occur and it has been some time since investors have experienced one. Many markets are in bear market territory now. The S&P 500 declined 19.75% so it technically did not enter a bear market, but the NASDAQ and several international benchmarks have declined 20% from the most recent peak. Again, it is important for investors to keep in mind that bear markets are only temporary unless made permanent. Additionally, although the declines can be unpleasant, the reward for being patient has always been substantial. The average bear market since 1926(and there have been eight) declined 41% and lasted on average 18 months. The average bull market over the same time horizon (there were nine) lasted on average more than 7 years and had gained on average 470%! Should the market weakness continue and the bear market extended, we will be looking for opportunities to rebalance away from bonds and into stocks to position portfolios for the next bull market.
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