The world endured an uncomfortable degree of political uncertainty and strife. The effects of the 2016 American election as well as other votes around the world continue to have significant geo-political ramifications. Remarkably, markets seemed to take political gyrations in stride and remained focused more on business and economics. The early months of 2018 proved especially challenging as technology stocks came under political scrutiny and trade conflicts erupted.
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 the employment market continued to expand and participation increased.
The prevalent view in recent years has been that interest rates had nowhere to go but up. Despite that consensus, rates have remained extraordinarily low. For years, the Federal Reserve has warned of the imminent onset of inflation, given economic growth and low unemployment. However, that inflation has yet to arrive, to the consternation of some, but to the relief of many more. It remains to be seen if the large tax cut passed at year-end 2017 will fuel inflation. Investors have remained skeptical, with long-term interest rates remaining fairly stable, even as the Fed has raised short-term rates and signaled that more increases are coming.
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. Savings, on the other hand, have fallen.
Every major region experienced economic growth, although there were some sputters in 2018. Europe’s economic recovery faded a bit. The British economy underperformed. Contrary to what most expected however, the Brexit soap opera has not had a drastic effect on British and European economies.
OPEC demonstrated restraint over the supply of oil and this had the effect of pushing prices upward. Demand rose as well. Nevertheless, American shale producers have proved quite resilient and it seems unlikely that there will be a huge oil price spike. The US is poised to become the world’s largest oil producer in the near future.
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 14%. 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.
Small-cap companies were standout performers with particularly large gains in 2018. Perhaps these companies have benefited from increased investor concern regarding the trade confrontations and its effect on the large globally-oriented firms??
International stocks lagged the US. The EAFE Index (predominantly Europe, Australia, and Japan) ended the year with gains of only half the gains of the S&P 500. Emerging markets fared a bit better overall, although the 2nd quarter of 2018 was brutal for several countries, particularly in Latin America.
Natural resource stocks surged in spring of 2018 and ended the year as the top performing asset class. (Note that this follows three consecutive years of losses). 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 neutral. Although international markets and REITs dragged on returns, small cap stocks and natural resources were positive influences.
The Fixed Income Markets
Bond prices fell in the first half of 2018, and this decline erased the gains produced during 2017. The total return of the US bond index was slightly negative: -0.5%. The Federal Reserve increased interest rates three times. Many corporate bonds fell in value as investors have grown more concerned with excessive debt on company books. International bonds fared slightly better and ended with small gains. Foreign central banks continue to actively intervene in the markets to keep interest rates low. Cash and similar investments have benefited from the Federal Reserve’s increases in rates.