The manufacturing sector of the economy ended 2018 on a relatively sour note.
Production weakened over the last few months of the year and December over December comparisons show a growth rate of about 2%. Certainly interesting that the stock market has continued to ignore the lackluster economic reports so far in 2019 and continues to foresee happier times ahead.
Factors influencing prices high: OPEC cuts, geopolitical situations involving Iran and Venezuela, slow but steady increase in demand.
Factors depressing prices: US domestic production at all-time highs; reasonably flush inventories; pressure from Trump on OPEC to keep prices low, and the global economic slowdown.
Although on balance the bears have the stronger case, for today it is the bullish side that is ascendant as oil prices are markedly higher.
The most recent PPI data shows that inflation continues to be dormant.
A fall in energy prices pushed the top line to a second straight decline. But even apart from energy, inflation remains quite tame. Very reassuring for the Federal Reserve as there is no statistical reason to tighten policy economics
With only 2+ weeks left until the truce expires on the trade war with China, the sides remain very far apart.
Zero progress seems to be made on the structural issue and although the Chinese have made several pledges about increase of exports, it is far from clear that these will come close to meeting the demands of the hard-liners from the American side.
Year in Review – 12 Months Ended December 31st, 2018
There was not much to cheer investors over the three months ended October 31st. Every major asset class – besides money market funds – experienced losses, although the retreat in bond values was fairly mild. Several relatively lackluster economic reports along with growing concern over the trade confrontations with China seemed to be the primary causes of investor unease. Only a few sectors of the market were able to gain in value (utilities and consumer staples). Short term Treasury bonds also rose slightly.
The world endured an uncomfortable degree of political uncertainty, much revolving around US efforts to revise the world trading/economic order. Remarkably, markets seemed to take political gyrations in stride and remained focused more on business and economics. Despite the apparent momentum behind populist leaders in several countries, corporate influence and profits remain at astounding levels.
Most national economic statistics were relatively strong. The year was exceptionally positive for the American economy and consumer. Moderate growth continued, purchasing power gathered strength due to low inflation, and wages rose a bit faster than in previous years as unemployment fell to levels considered impossible just a few years ago.
Interest rates have risen, both due to Federal Reserve actions and in response to economic strength. For years, the Federal Reserve has warned of the imminent onset of inflation, given economic growth and low unemployment. The absence of inflation has prompted a re-think at the Fed and official optimism on this front has increased. It remains to be seen if the large tax cut passed at year-end 2017 will fuel inflation. Tariffs also have the potential to filter into inflationary pressures.
Major Economic Events
Growth in the US was a bit above average. Employment expanded at an increased clip, inflation remained under control, and housing prices rose. Consumer confidence surged, and spending remained fairly high. Another under-reported economic event occurred when government statistician’s discovered that official data has - for years - been understating the savings rate, and that indeed the economy was better balanced between spending and saving than had been reported.
Every major region experienced economic growth, although there were some sputters in 2018. Europe’s economic recovery faded a bit. The British economy unperformed. Contrary to what most expected however, the interminable Brexit saga has not had a drastic effect on British and European economies.
OPEC, in concert with Russia, demonstrated restraint over the supply of oil and this had the effect of pushing prices upward. Demand rose as well. Another factor pushing oil prices upwards was the prospect of several US economic sanctions on Iran.
The Equity Markets
US stocks fell in the first quarter of 2018, breaking a string of nine consecutive gains. The stock market rally then resumed in spring. Despite increased volatility, the broad US equity market ended the twelve month period with gains of roughly 18%. Technology stocks were the clear leader, while more stable sectors such as consumer staples and telecom providers lagged significantly. Growth stocks trounced value, a result due primarily to the impact of the tech stock boom.
International stocks lagged the US. The EAFE Index (predominantly Europe, Australia, and Japan) ended the year with relatively meager gains. Emerging markets were faced with numerous headwinds, most of which emanated from US economic and political pressures. Currencies fell in relation to the strong US dollar. The Trump administration policy of confrontational trade stances and tariffs significantly impacted many emerging markets, most particularly China. Lastly, several countries paid the price for economic mismanagement and political turmoil, most notably Brazil and Turkey.
Natural resource stocks surged in spring of 2018 and ended the year with respectable gains. REIT prices fell during an inflation scare in February. A quick rebound left this asset class slightly ahead for the year.
Overall, the effects of diversification from the traditional S&P 500 index were very negative. Every major asset class fell significantly short of the S&P 500, with the exception of small-cap growth stocks. These were boosted – as was the S&P 500 itself - by sizable exposure to technology.
The Fixed Income Markets
Bond prices have fallen during 2018, and this decline erased the gains produced during the final quarter of 2017. The total return of the US bond index was slightly negative: -1.2%. The Federal Reserve continued its policy of gradual rate increases. Many corporate bonds fell in value as investors have grown more concerned with excessive debt on company books. International bonds fared no better. One bright spot were inflation-protected Treasuries, which ended the year with small gains. Cash and similar investments have benefited from the Federal Reserve’s increases in rates.
For those of you that were unable to join us Thursday night, please click the Play button below to listen to our Investment Conference Call where I discuss the recent performance of the economy, markets and the role that international assets play in our portfolios.