The year began like the last few years with US stocks moving markedly higher. After a quick blip in February, domestic equities continued the rise to which we have become accustomed through September, despite the Fed raising interest rates, slowing growth in China, and the potential for a trade war.
Unfortunately, the effects of quantitative tightening finally caught up. Equity investors have enjoyed the benefits of quantitative easing, and stock prices have moved precipitously higher for nine consecutive years. But, since 2015 the Fed has raised interest rates eight times and central banks around the globe have begun winding down their accommodative policies. The tightening of the money supply has led to the worst year for investors in the last 100 years. With over 90% of the 70 asset classes tracked by Deutsche Bank providing negative returns, there were few safe places to hide.
Until September, US equity investors remained unharmed, but from its peak, the S&P 500 dropped 19.8% when it hit its low on Christmas Eve, narrowly missing bear market territory. For the quarter, the S&P 500 declined 13.5%. So, after nine consecutive years of growth, the S&P 500 broke this abnormal trend and declined 4.38% in 2018. Small cap investors fared more poorly, losing over 11%.
International stocks and emerging market stocks declined even further. The MSCI EAFE Index dropped 13.8% and the MSCI Emerging Markets Index fell 14.6%. Although US stocks avoided a bear market, some international markets were not as fortunate. During the year, China’s Shanghai Index, Hong Kong’s Hang Seng Index, and Japan’s TOPIX all declined more than 20% from their peaks.
With the rise in rates, fixed income markets provided little relief. Short term, high quality bonds gained approximately 1%, but long-term, high yield, international, and emerging market bonds all delivered negative returns. The Fed’s interest rate increases, and the belief that the US economy has peaked, led to a continued flattening of the yield curve throughout the year; however, the curve did not invert.
Alternative asset classes likewise did not offer positive performance. Real estate was off 4% and commodities, led by the drop in crude prices, declined more than 11%. Due to increased production in the US, Russia, and Saudi Arabia along with waivers granted to India, China, and other countries for Iran deliveries, oil fell more than 30% in a matter of weeks from a four year high.
Despite the 4th quarter volatility swings, the volatility index remained within normal ranges and only triggered our dynamic hedging strategy twice during the year for two brief periods.
While investors did not suffer the pain of 2008, the decline in almost every asset class left few investors unharmed, and market psychology has changed considerably from the start of 2018. Now, anxiety pervades. Adding to this unease, 2019 begins with a government shutdown, political battling between the Trump administration and Democrats, little, if any, progress in trade negotiations with China, and global economic growth showing signs of weakness. US corporations continue to benefit from tax cuts and repatriation, but earnings are expected to slow. However, corporate growth remains strong and inflation is subdued, so there is little chance of a recession this year.
Washington Trust Bank believes that the information used in this study was obtained from reliable sources, but we do not guarantee its accuracy. Neither the information nor any opinion expressed constitutes a solicitation for business or a recommendation of the purchase or sale of securities or commodities.
Washington Trust Bank.