Investment Review for Fourth Quarter 2018

Fluctuating financial markets.

Early in 2018, a flurry of optimism took stock prices higher week after week, setting new all-time highs along the way. In late January, market sentiment faltered, and U.S. stocks sold off more than 10% in just a few days. Following the sell off, risky assets oscillated for several weeks, but by the end of April, U.S., foreign developed, and emerging market stocks were basically even for the year.

In early May, a great divergence began to appear as the combined pressure of increasing tariffs, rising geopolitical tensions, and the strengthening U.S. dollar began to take their toll on foreign stocks. Over a five-month period, U.S. stocks gained value while their foreign counterparts fell.

The party ended for U.S. stocks in the fourth quarter as shares fell sharply, bringing the S&P 500 to the brink of a bear market in late December. While all risky assets suffered during this time period, there was a clear shift in the trend, with domestic stocks suffering more than their foreign counterparts. When combined, 2018’s down periods outweighed the up periods and risky assets across the board ended the year negative.

Major asset class returns.

Interest rates.

Short-term interest rates started 2018 just below 1.3%. Four evenly spaced rate hikes from the Federal Reserve helped short-term rates gradually increase throughout the year. At year-end they reached 2.44%, their highest level for 2018.

The interest rate for 10-year government bonds began the year at 2.46% and rose as high as 3.24% in November. But as stock prices began to fall and fear mounted, investors seeking the safety of bonds pushed interest rates on 10-year bonds down to 2.69% by year end. As a result, there is little incentive today to lock up money for 10 years at 2.69%, when the yield on shorter-term investments is so close.

Federal government shutdown.

There have been 18 gaps in funding for the federal government over the past four decades. Prior to 1980, many federal agencies continued to operate during funding gaps, believing that money would be restored soon, and that Congress didn’t intend for them to close down. But in 1980 and 1981, the Attorney General issued two opinions that required agency heads to suspend operations until funding began to flow again. As such, only employees whose jobs are related to the “safety of human life or the protection of property” will continue to work (without pay, mind you).

While opinions are mixed on whether the government shutdown is good or bad depending on one’s political beliefs, there are definite ramifications for the economy. There will be a loss of productivity from federal workers, lost revenue from government museums, parks, etc., and interest due on missed payments during the shutdown. There is also economic disruption on the private sector resulting from delayed permit and licensing approvals, halted SBA (Small Business Administration) loans, tourism shifts, lending and repayment issues resulting from cash-strapped federal workers, altered consumption patterns, and increased uncertainty in the financial markets due to discontinued economic data releases.

Economic activity.

Economic activity was strong in 2018, but what is in store for 2019? While the government shutdown has slowed the release of some data, manufacturers’ new orders and retail sales both looked good through October and November respectively. A dip in either of these two areas could be a sign of future weakness in the economy. On the job front, weekly first-time unemployment claims remain extremely low, which indicates continued strength in the job market. In contrast, housing starts having been declining a bit over the past few months—somewhat attributable to higher mortgage interest rates.

In terms of confidence in the economy, the lead up to and subsequent closing of the government, fears of slowing global economic growth, and jitters in the stock market have led to a decline in sentiment. The most recent readings from the purchasing managers’ survey, small business optimism survey, and consumer confidence survey all declined. All three readings are still at high levels, but should the downward trend continue it would likely be a sign of weaker economic activity to come.