Market Update – Dec. 24, 2018
Sixty-four. Sixty-four trading days is all it took to wipe out what had been an +11.2% year-to-date gain on the S&P 500 and turn the year into nearly an -8% loss. If Friday had been the last day of the quarter, which it was not, Q4 2018 would rank as the sixth worst quarter in the last half century.
Source: Thomson Reuters Eikon. Data as of 12/23/2018.
One observation that jumps out from this list: excluding the current quarter, every one of the quarters listed above were during a recession except for Q4 1987 (Black Monday) and Q3 2011 (debt downgrade/double dip fears). We’ve taken some liberty to lump Q2 & Q3 of 2002 as part of the 2001 recession – technically those two quarters did not fall within the dates of the 2001 recession, but they were part of the same bear market.
Unless the market can manage an 8.5% rebound in the last four and a half (12/24 is an early close) trading days of the year, this will be the first annual decline in the S&P 500 in a decade (2008). We have, however, had some close calls over the last ten years: 2011 saw the index finish within pennies of where the year started (which led to a 2.1% total return when dividends were included), and 2015 similarly saw a slight decline in the headline index and a 1.4% gain when dividends were included. To be sure, we’ve had periods since the Great Recession where market returns were negative on a one year rolling basis, and there’s nothing particularly special about a calendar year being negative. For example, we are no more upset that 2018 will likely deliver a negative return than we were on 2/11/2016 when the S&P 500 logged a -9.6% trailing one-year return. However, there’s no denying that on every calendar-year asset class return chart going forward, 2018 will (likely) stick out as the year that broke a nearly 10 year stretch of uninterrupted calendar year gains in the index. In the last thirty years, the index has only produced negative total returns six times (90, 00, 01, 02, 08 and possibly 2018).
The real question is: are we in or are we headed into a recession? Interestingly, if the S&P 500 doesn’t close down 20% from the all-time highs, this volatile period will fail to gain “bear market” status, and someday young investment professionals will point at a chart of the S&P 500 and ask, “what was that?” The severity of this sell-off is running hotter than the previous two bear markets thus far.
Source: Thomson Reuters Eikon. Data as of 12/23/2018.
This time more than most, we do not believe any single catalyst caused this sell-off. Nor do we think, when taken in aggregate, they should have caused a sell-off of this magnitude. There’s nothing meaningful in the data that would justify such a move. Below is a list of just some of the reasons cited by market participants.
- Federal Reserve monetary tightening
- Prospect of Impeachment
- International growth slowdown
- Tariff concerns
As of late, the most cited reason has been Fed tightening. Just for some perspective, the Fed has increased the Fed Funds Rate ~2.25% over the past three years. In comparison, from 2004 to 2006 the Fed raised rates 4.25% over the course of two years. The pace was quicker and the level higher in the last cycle.
We are increasingly concerned the selloff is related to internal turmoil in the US administration. As a general rule we stay out of politics, but we cannot ignore the pace of resignations/firings since the midterm election. Specifically concerning was the resignation of President Trump’s Secretary of Defense, General Mattis, over differing views of America’s military role internationally. Although we believe the pace of turnover will slow in the new year, the now blue House of Representatives are in the starting gates and (as they will often remind you) they now have subpoena power and are ready to use it when the new Congress is seated.
What does the rest of the investible universe look like? Below are some of the broad asset class indexes we follow:
Source: Thomson Reuters Eikon. Data as of 12/23/2018.
There are no two ways about it, this has been a difficult year for risk assets. The worst in a decade for US stocks, as mentioned previously.
As you can imagine, we’ve fielded a lot of questions about what we are doing in client portfolios. We spent the last week harvesting losses in our taxable portfolios. As fear grew and our view of the macro backdrop remained unchanged, we also rebalanced portfolios back to our strategic targets. In doing so, we started to increase our beta exposure to nearly one after running well below one in the first half of Q4. Finally, on Friday we increased our equity exposure to the upside if we should get a bounce back in the next six months. We are always open to the possibly the next recession is upon us and we do not believe one must wait until a recession is confirmed to take action, but today we do not see the conditions necessary for a recession in the next 6-12 months. That could certainly change, but for now, at 15.3x next year’s earnings US stocks are the cheapest they have been on a sustained basis since 2014 (except for short-lived periods during the oil & gas downturn in the middle of 2015 and early 2016). The data and earnings expectations would have to change in a meaningful way for that to change.
The views expressed in this newsletter represent the opinion of Custos Family Office, a Registered Investment Adviser. This material is for informational purposes only. It does not constitute investment advice and is not intended as an endorsement of any specific investment or services. The information provided herein is obtained from sources believed to be reliable, but no representation or warranty is made as to its accuracy or completeness. Investing in equity securities involves risks, including the potential loss of principal. While equities may offer the potential for greater long-term growth than most debt securities, they generally have higher volatility. International investments may involve risk of capital loss from unfavorable fluctuation in currency values, from differences in generally accepted accounting principles, or from economic or political instability in other nations. Past performance is not indicative of future results. Investments are not a deposit of or guaranteed by a bank or any bank affiliate. Please notify Custos Family Office if there have been any changes to your financial situation or investment objectives or if you wish to impose or modify any reasonable restrictions on the management of your accounts through Custos Family Office.
