It may seem contradictory that 2018 was a strong year economically yet the stock market took a sharp downturn at the end. However, this seeming paradox is not at all uncommon — it’s been going on for more than half a century. If we analyze the recent market volatility through a historic lens it can guide us on the best investment course to take in 2019.
By most measures, 2018 exhibited the strong growth that most economists predicted when the year began. The U.S. economy grew by 3.25%. When U.S. corporations report fourth quarter earnings at the end of January a 20+% year-over-year growth rate seems all but assured.
In addition, the unemployment rate dropped to a 50-year low (3.7%), wages ticked solidly higher, and core inflation fell nicely within the Federal Reserve’s target range (2.2%). In December alone, the US economy added nearly twice as many jobs as economists expected.
Despite these robust economic measures, the S&P 500 posted the worst December since the Great Depression. For the year, the S&P 500 declined -4.4%. Global equities fared even worse. Stunned investors were left wondering how the economy could move in one direction and the stock market in another. Let’s look at how this happened — and at some similar situations in the past — which may shed light on the year ahead of us.
WHAT CAUSED A SELLOFF?
While the recent situation was disconcerting, it is not at all unusual for markets to move in a different direction than other economic indicators, such as the Gross Domestic Product (GDP) or business hiring. The key is for investors to identify the underlying reasons for the stock decline, and evaluate whether those indicators are likely to be resolved (example: trade dispute) or point to a coming recession.
In 2015, for example, the U.S. economy experienced its best growth in a decade. However, starting in June of that year, the value of stock prices globally began to fall in what became known as “the 2015-16 stock market selloff.” The anchor to stock prices was a major selloff in oil, coupled by a material decline in corporate earnings, which we now know was just a mid-cycle pause. In 2011, “Black Monday” saw an August crash in the US and global stock markets. In a single turbulent day, investors lost a trillion dollars. The main headwind was the European Debt Crisis and the potential collapse of the European Union. That perceived crisis passed.
LESSONS FROM THE KENNEDY SLIDE
To find the most pertinent example, you need to go back more than 50 years ago, to the so-called “Kennedy Slide” of 1962. After a long bull run in the 1950s, the S&P 500 plummeted 22.5% in the first half of the year. Arguably, this selloff was instigated by uncertainty between the Kennedy Administration and the business community. At the time, President Kennedy was caught in a public dispute with the CEO of U.S. Steel, Roger Blough.
Ultimately, Blough gave in to intense public and political pressure, and the Kennedy Slide ended up being short-lived. The market indexes hit new all-time highs just 14 months after the trough.
The “Kennedy Slide” has stark parallels with the recent market selloff. Just like the “Kennedy Slide,” the recent situation occurred after a long bull run, which began in 2009. While it’s impossible to attribute the recent sello to a definitive cause, it certainly feels connected to uncertainty surrounding our trade relationship with China and concern about the possible impact of a federal government shutdown.
Why is this parallel worth considering today? Just as the stock market recovered in 1962 after the underlying triggers were addressed, we believe 2019 could rebound if the causes of the recent selloff are remedied. In this case, it would require the US to reach a trade agreement with China and the Federal Reserve to hit the pause button on rate increases by mid-year. The federal government would also need a longer-term resolution to its budget impasse.
In most cases, bear markets and steep declines occur alongside recessions, but we still do not see substantial evidence that a recession is on the close horizon. The Conference Board’s Leading Economic Indices (LEI) for the US and Eurozone remain in long up trends, and virtually no major investment bank or manager — from Goldman Sachs to Credit Suisse to Morgan Stanley to Blackrock — believes that we are headed for a recession in 2019. Ashfield Capital Partners does not believe the global economy is headed for recession in the new year, either.
WHAT THIS ALL MEANS NOW
The main takeaway from historical events is market selloffs without recessions tend to be temporary events. If market fundamentals remain strong, we do not expect last year’s late market selloff to extend into a prolonged bear market.
At the same time, there is little doubt that the U.S. economy is likely to slow some in 2019. With a slowing economy comes increased risk and lower return expectations – an environment we believe requires an even greater focus on investment quality.
A company’s competitive advantage, growth opportunities, earnings momentum, and reasonable valuation will be increasingly important distinguishing factors driving our investment selection process. In addition, asset allocation between stocks, bonds, cash, and alternatives should be reviewed to make sure portfolio risk/reward characteristics are in- line with investment guidelines and objectives.
If you have any questions or would like to discuss anything with us, please do not hesitate to reach out directly.
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