If there was a year in which there might be a primacy and recency effect, 2018 would be it. Things began on a great note for market bulls and they ended on an otherwise dreadful note, notwithstanding a rally effort in the last few sessions.
How good was the start? The S&P 500 gained as much as 7.0% in January before closing out the month up 5.6%.
How bad was the finish? The S&P 500, as of this writing, had fallen 15.0% since the close on October 1, but it had been down as much as 19.8%. At one point, the S&P 500 was down 15.0% for the month of December alone!
The answer is that a lot happened in between to drive a major swing in investor sentiment and a major upswing in volatility. The constant throughout the year, though, were ruminations about interest rate moves.
The roaring start to 2018 was a continuation of a roaring finish to 2017, which was fueled by optimism surrounding a fiscal stimulus plan that was approved and went into effect in 2018.
The central feature of the plan was a reduction in personal income and corporate tax rates, both of which were seen as fuel that would drive a pickup in consumer spending, a pickup in business investment, a pickup in employee wages, and a pickup in earnings growth.
By and large, that vision was realized, only the pickup in some cases, like business investment and employee wages, wasn't quite as strong as forecast.
The latter point notwithstanding, there was a clear pickup in GDP growth in 2018, which averaged 3.3% on an annualized basis over the first three quarters versus 2.5% for the first three quarters of 2017. That pickup was led by increases in personal spending following the implementation of the fiscal stimulus plan.
The economic momentum translated into revenue and earnings growth momentum for S&P 500 companies that was remarkable.
According to FactSet, the 10.5% increase in second quarter revenue was the highest growth since Q3 2011; the 26.0% EPS growth in the third quarter was the highest since Q3 2010; and the 20.3% earnings growth projected for calendar 2018 would be the highest for the S&P 500 since calendar year 2010.
The economic and earnings growth momentum helped stabilize the market following a major drawdown in February that culminated with the first 10% correction for the S&P 500 in nearly two years -- a correction that unfolded over just ten trading sessions.
That drawdown got going on a sense that the market had gotten overextended, but it shifted into a higher gear following the release of the January employment report, which revealed a larger than expected increase in average hourly earnings that ignited concerns about the Federal Reserve ("Fed") raising rates aggressively to keep inflation in check.
It was the collapse of short volatility ETFs, though, that forced some panicky selling that took the S&P 500 down as much as 10.3% in February. By the end of the month, the S&P 500 was down "just" 3.9%.
The ability to regroup was helped in part by the good earnings news, as previously mentioned, yet it was also helped by a rationalization in the market's mind that rising interest rates were a good thing in the sense that they went hand-in-hand with an improving economy that would be good for earnings growth.
Eventually, the S&P 500 would climb to a new record high of 2940.91 by September 21, shaking off many concerns along the way, like rumblings over the potential dissolution of NAFTA, talk of peak growth in economic activity and earnings, the inability of the UK to come up with an agreeable Brexit plan, and a protectionist trade policy pursued by the U.S. in an effort to cut trade deficits with major trading partners.
The protectionist action featured the implementation of tariffs on imports of steel and aluminum, and more comprehensive tariff action on more than $200 billion worth of goods imported from China.
The U.S., Canada, and Mexico ultimately reached an agreement on a new NAFTA deal, known now as the United States-Mexico-Canada agreement (USMCA), which is still awaiting Congressional approval; the US and European Union ultimately agreed not to hit each other with new tariffs as they engaged in talks aimed at reducing tariffs and trade barriers; and the U.S. and China ultimately agreed not to escalate tariff actions further for 90 days (ending March 1, 2019) as they try to work out a deal to correct structural trade issues.
The trade war with China (that's what we'll call it) was an overhang all year, yet it didn't hit the stock market that much since the impact of the tariffs, and retaliatory tariffs, hadn't shown up to any significant degree in the data -- other than in imports from China, which were pulled ahead to circumvent impending tariff actions.
Nevertheless, as the year drew to an end, the stock market was plenty pre-occupied with worries about U.S.-China trade relations. There was concern that a trade agreement wouldn't be struck in the prescribed time window, raising the specter of the U.S. following though on a threat to raise its tariff rate on imported goods from China to 25% from 10% and to put new tariffs on even more Chinese imports.
The U.S. and China are slated to hold trade talks the week of January 7, and it's safe to say that those trade discussions, and others that may follow, will be a focal point at the start of 2019.
We don't want to get ahead of ourselves, though, considering this is a year in review piece. For our perspective on the 2019 market view, readers should click here.
Turning back to 2018, the Fed factored prominently in trading matters, not only because it elected to raise the target range for the fed funds rate four times and cut the size of its balance sheet in an effort referred to as "quantitative tightening" (the converse of "quantitative easing"), but also because those actions were derided by President Trump as being misguided.
President Trump didn't hide his his feelings about the Fed's actions, saying he wasn't happy with his pick of Jerome Powell to be Fed Chair. That public criticism created some nervous trading behavior in the stock market, which felt the Fed's independence was being put to the test by the president's remarks in a way that made it impossible for the Fed not to raise rates.
Fed Chair Powell made it clear, after the Fed elected in December to raise the target range for the fed funds rate for the fourth time this year, that the Fed is not swayed by political opinions and that its decision making is (and will be) data dependent.
That reminder came at the same time updated projections from the Fed revealed a median estimate for two more rate hikes in 2019.
The stock market wasn't a fan of the rate-hike outlook, and it was left to think the Fed might be on course to make a policy mistake by raising rates too much.
That consideration contributed to a major downturn in the month of December, which added to losses that started to mount at the start of October as peak growth concerns hit home amid a steady stream of disappointing data from abroad, a flattening of the yield curve, and ugly performances by cyclical sectors here at home, and stocks in general, that were viewed as harbinger of slower growth ahead.
The best manifestation of those growth concerns was the compression in the P/E multiple despite the S&P 500 being on track to deliver its best year of earnings growth since 2010.
To that end, the forward 12-month P/E/ multiple for the S&P 500 stood at 18.3x entering 2018. Today, it stands at 14.4x.
Everything got caught up in the jet wash at the end of the year, including the FAANG stocks, which were all but invincible in 2017. The selling pressure on those names -- Facebook, Apple, Amazon.com, Netflix, and Alphabet - was acute and was a major drag on the broader market given their collective market weight and how widely owned they are in passive and active funds alike.
Every sector was down at least 4.5% in December. In the fourth quarter, meanwhile, eight of 11 sectors saw double-digit percentage declines ranging from 10.3% (health care) to 24.7% (energy). The bloodletting in the energy sector was a byproduct of the bloodletting in oil prices, which collapsed 41% from their October 3 high on the back of concerns about excess supply and a global growth slowdown.
There was only one sector -- the defensive-oriented utilities sector (+0.3%) -- that had eked out a quarterly gain as of this writing.
A year that began with a bang on the back of optimism about the economic and earnings outlook ended with an audible thud on the back of concerns about the economic and earnings outlook.
Having done so, it left the S&P 500 on the cusp of registering its first decline on a total return basis since 2008. That decline will be relatively modest in scope, yet it will feel a lot worse given how significant -- and rapid -- the sell-off was from the all-time high hit in September.
2018 will also go down as an historical anomaly. To wit, the Stock Trader's Almanac informs us that there has never been a down year for the market since 1950 when the S&P 500 has gained at least 4.0% in January.
That streak will come to an end barring a rally of epic proportions in the final trading session of the year that will take place as a partial government shutdown persists due to an inability to reach an agreement on a funding bill.
The partial government shutdown was one more negative at the end of a year that had been primed to be a positive one but more recently turned into a negative one.
Thank you for your readership throughout the year. Best wishes for a happy, healthy, and prosperous 2019!
(Note: The next installment of The Big Picture will be published Friday, January 11)
|Dow Jones Industrial Average||-6.7%|
|S&P Midcap 400||-13.4%|
*Returns through December 28, 2018