The world endured an uncomfortable degree of political uncertainty, much revolving around US efforts to remake the world trading/economic order. After a long period of investor complacency, concerns about the impacts of this policy were clearly demonstrated by the end of 2018. Despite the apparent momentum behind populist leaders in several countries, corporate influence and profits remain at astounding levels. Despite much turmoil, conditions favor investors and the stock market rebound of early 2019 reflects this.
Most national economic statistics were relatively strong. The year was positive for the American economy and consumer, although growth slowed as the year wore on. 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.
The Federal Reserve began the period intending - in response to a strong economy - to continue to raise interest rates and shrink its swollen balance sheet. 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. Tariffs have the potential to filter into inflationary pressures, although to date effects have been hard to detect.
Major Economic Events
Growth in the US was slightly above average. Employment expanded at an increased clip, inflation remained under control, and housing prices rose. Consumer confidence remained very high, as evidenced by high spending. The corporate tax turbocharged profits, which were already at extremely high levels.
The global economy expanded but growth faded. Europe’s economic recovery stalled as several countries fell into recession and even Germany’s growth waned. The British economy underperformed. Contrary to what most expected however, the interminable Brexit saga has not had a drastic effect on British and European economies. China’s growth continues apace but is far below the rate achieved during the past decade. The Chinese government has struggled to develop policies to manage the trade war’s impacts.
Oil prices plunged at the end of 2018. American supply has surged, OPEC’s efforts to contain the market sputtered, and the drastic sanctions that were to be placed on Iran’s oil exports never materialized. Although energy prices rebounded very strongly in 2019, they remained below the year earlier level.
The Equity Markets
With a few notable exceptions, it was a subpar year for global stocks, with an overall appreciation of just over 2%. Stock markets endured a very sharp fall during the 4th quarter, followed by a surge in early 2019. An unfortunate confluence of a Federal Reserve interest rate hike, some tepid economic news, and the proclamation by President Trump that he is a Tariff Man shook investor confidence dramatically. In 2019, some of these trends seemed to reverse, as a trade deal with China was repeatedly proclaimed imminent and the Fed dropped its plans for steady rate increases. Corporate profits remain extremely high and stock buybacks continued to support the overall market.
As mentioned above, certain asset classes did fare well. The American stock market held up better than its international counterparts. Most international markets ended with losses, while the broad US stock market achieved respectable gains. Within the US, large cap growth (technology, health care) dominated although several other sectors (real estate, utilities) turned in surprisingly strong results. Small cap stocks lagged significantly, although managed to eke out small gains.
Europe, Japan, and emerging markets ended the year with comparable losses. Europe and Japan’s economic results were unimpressive. The Trump administration policy of confrontational trade stances and tariffs exacerbated the situation and significantly impacted many countries, most particularly China.
Natural resource stocks tracked the price of oil and ended the year down slightly. REIT investors celebrated the cessation of the Fed tightening and the fall in interest rates.
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, except for REITs.
The Fixed Income Markets
Bond prices rallied as stock prices fell in October and December and then rose again in 2019 as the Fed signaled an end to tightening and interest rates for most bonds tumbled. International bonds fell a bit as the overall trend in the dollar was upwards. Cash and similar investments have benefited from the Federal Reserve’s increases in rates and the rate of return on money market funds approximately matched the inflation rate.
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.