Quarterly Commentary – December 2018

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December 2018 will go down as the worst month since October 2008 for the U.S. stock market and the worst December since 1931. Year to date the results have been negative for both U.S. equities and for international equities, although the latter held up better during the past quarter. The following are performance numbers from various popular indexes. Please remember index numbers are not individually comparable to a properly diversified portfolio. Each portfolio may include an allocation to securities similar to these indexes in varying amounts based on your personal risk tolerance and should only be compared in that context. The S&P 500 was down 4.4% for 2018. The Dow Jones Industrial Average was down 3.5%. The Nasdaq Composite Index was down 2.8%. The Russell 2000 Index was down 11.0%. International equities as represented by the MSCI AC World Ex U.S. Index were down 14.2%%. The MSCI Emerging Markets Index was down 14.6%. Fixed Income as represented by the Barclays Aggregate Bond Index ended flat for the year.

There are certainly some concerns out there but are things as bad as they were during the depths of the financial crisis? The surprise for most investors is the apparent disconnect between the status of the economy which is in good shape with a strong consumer and the size of the recent moves in the market. We are however reminded that markets are forward looking in that they adjust for expectations about the future and are less about what has happened or is going on currently. Sentiment plays a big factor short term and things don’t always stay rational. So, what are the reasons behind the decline? The obvious culprits are the expectation of a global slowdown and fear of contagion and the possibility of recession. The Federal Reserve raising rates, seemingly to be out of sync with what the market sees as potential headwinds while providing a confusing message about the future. Rate increases and a balance sheet reduction after years of an extremely accommodative monetary environment is uncharted territory. Adding to that, we have a trade war, a government shutdown, the resignation of the Secretary of Defense and the U.S. pulling our military out of Syria and partly out of Afghanistan despite strong dissent from the establishment. This has created a recipe for unease and uncertainty. Markets hate uncertainty more than anything. Slowing growth was in the cards given the high pace of recent quarters. Interest rates still remain on the low end by historical standards. Inflation is still in check despite historic low unemployment. Growth, although slowing should be decent and stock market valuations have come down enough that they price in some fairly low company expectations for next year. Fear of a policy mistake by the Fed is a major factor playing into the unease, particularly since the primary reason behind most prior recessions involved some type of policy mistake by the Fed and often were preceded by the Fed having started raising rates. Add to this the political uncertainty and what is going on in Washington might be a preview of things to come for the next couple of years. These concerns however can quickly shift, particularly given that some of these appear to play heavily on perceptions and sentiment.

It is also worth noting that historically the equity market does correct from time to time and although much of what is described above is significant, it is for the most part a catalyst for shifting expectations. It triggers volatility but does not change the reality that markets make these types of moves fairly regularly. After the kind of run up we have had, the stock market can become more vulnerable to downturns and participants have the need to attach some sort of explanation. Once the selling begins, it begets more selling which is often based on prevailing emotions of the herd looking for some exit. Automated trading tends to exacerbate the moves. Tax loss selling is also a factor this year given the losses that were generated this quarter. The selling is usually overdone by its nature. In this environment the good and the bad get sold indiscriminately, particularly with the significant use of funds which contain a wide range of securities, some worth selling, some not. Historically, things have always recovered. Putting market pullbacks into perspective during the post WWII era, we have experienced 27 declines between 10-20% averaging a 13% decline over four months and a recovery time of 3 months. On average, we get a 10% or more decline every year and a decline of 15% or more every 3 years. Also keep in mind that this recent decline is coming after some substantial multi-year gains. No one can predict when those pullbacks happen or how long they last. The fact that we were historically due for one is probably as much a factor as any. Now, were there some unnecessary self-inflicted wounds leading to this point, probably so, but that usually spells opportunity for adding new money into the markets and finding the gems that were thrown out in the scuffle. At this point, stock market valuations are very good by historical standards. We are still in a growing economy with a business-friendly environment.

We understand that this can be a frustrating time, however this will pass as it always has. Patience gets rewarded. We are thankful for the opportunity to serve you.