Fourth Quarter Market Overview For 2018
The intent of this blog is to provide an update on the state of the domestic and international stock and bond markets, as well as provide insight into Lighthouse Financial Services long-term outlook.
As we stated at the beginning of the year, this market would not be as spectacular as 2017, and it would be more volatile. The market delivered just that.
Stocks bookended the beginning and end of the year with drops, despite returning over 10% in the two middle quarters. The Dow Jones Industrial Average and the S&P 500 dropped, respectively, 3.5% and 4.4% for 2018. Smaller firms (S&P 600) were worse, dropping 8.5 % last year. During down markets, defensive styles are usually safe havens – not this time. Counterintuitively, growth and momentum stocks were the only broad styles not in the red for 2018. Volatility, as measured by VIX, started the year at about 9 and ended at 21, just north of its historical average of 20.
Of the 11 domestic sectors, only three ended positive – healthcare, utilities, and consumer discretionary sectors. Technology and Consumer Discretionary moved drastically, adding, then dropping, over 20% of gains to end roughly flat this 2018. Long-term growth estimates for the entire market (S&P 500, below) remains near 10%, but down since our last review. Below, note the most recent earnings estimates for all 11 sectors and the S&P 500 (SSGA Dec. 2018). Of particular note is the communication services sector with the biggest decline in growth estimates (see graph below), and the utility sector, the only growth positive revision.
Developed and emerging markets lost 14.3% and 13.5%, respectively, in 2018. International markets (S&P ex-U.S.) suffered from geopolitical concerns (tariffs…) and also a slowing pace of growth. While emerging markets have been heavily downgraded, domestic value and developed markets still have a margin of safety against their fundamentals. (see graph from State Street/Factset). Fundamentals refer to common metrics such as earnings, cash flow, etc.
Clients holdings bonds with Lighthouse Financial did well last year, up about 1.2%. Yes, this isn’t much, but it’s attractive compared to the Barclay’s Capital Bond Index, ending flat in 2018. Interest rates and inflation didn’t rise much, with 10-year Treasuries yielding about 2.5% at the beginning of the year and ending at 2.7%. But the Federal Reserve raised rates four times last year. The bond market finally realized that high yield bonds can be overbought, with corporate and high yield bonds losing between 1 to 2 percent for the year. True to the bond strategy’s purpose, it shielded our clients from some of the recent market volatility.
Domestic economic indicators remain positive but less so than in 2017. We remain bullish, but for those of you who follow your accounts closely, you will begin to note the addition of higher weights to defensive sectors and lower foreign exposure. In addition, for the last 18 to 24 months we have slowly moved your bond portfolios to more moderate risk and shorter maturities. However, don’t confuse a move to a slower growth strategy as a defensive shift. For more details, every weekday you can view our market updates on our website.
Historically, over the long-term, the stock market should deliver about 7% annually, and bonds about half that, 3.5%. To repeat from last quarter’s update, a well-thought plan won’t guarantee a positive outcome but it will reduce the probability of a negative outcome. The bottom line, focus on your long-term goals and take the time to meet with your wealth manager regularly.