After the wild ride that December turned out to be, investors were exhausted and ready to close the books on 2018. When it was all over, it was difficult to remember all the record setting statistics that we enjoyed earlier on in the year. It seems hard to believe after the worst December since 1931, that it was just back in September when the S&P hit all-time highs followed by a record high on the Dow on October 3rd. The records that were set during December were not the type you want to remember. For the month, the S&P 500 lost 9.18%, the Dow gave back 8.66%, and the Nasdaq shed 9.48%%. That led to losses across the board for the year and although it could have been much worse, declines of 6.24%, 5.63%, 3.18%, for the S&P 500, the Dow and Nasdaq respectively, was a painful end to a difficult year. This was evidenced in the VIXX or volatility index, often referred to as the “fear” gauge, which was up 40.68% for the month of December alone and 130.25% for the year. Its no wonder that fear was escalated, the S&P 500 was up or down more than 1% nine times in December alone. That compares to eight times for all of 2017. It moved that much 64 times over the year. The Dow swung over 1000 points intraday only eight times in history, we got five of them in 2018.
So, what went wrong? Many would point blame to the Federal Reserve and their unrelenting rate hikes, the final one for the year in mid-December. With the economy beginning to show some signs of slowing, markets were hopeful to get some indication that the Federal Reserve was ready to pause on raising rates. After three consecutive hikes by the Federal during the year, short rates are considerable higher than where we started the year. Two-year treasuries moved from 1.88% to 2.49%, representing a 32.12% increase. Although long term rates did close higher, they traded at higher levels during the year. Closing out the year at 2.68%, ten-year treasury rates were 11.59% higher than where we started the year. Borrowing costs were a topic of conversation for much of 2018, with concerns on everything from consumer debt, car loans and the mortgage market.
We need to remember that this comes with a backdrop of the lowest unemployment rate in nearly 50 years, low inflation and rising wages. Interest rates sit at the center of the economy and therefore this debate is not yet over. After the longest period of zero percent interest rates, the road to normalization will not be easy. In his prepared statement following the announcement of the December rate hike, the Federal Reserve president focused on the strength and the health of the economy. He was clear on his intent when he stated, “Policy at this point does not need to be accommodative.” Although he did address the issues facing the economy and the potential for a slowing in 2019, he did not offer a clear vision of the path for rates next year as many investors had hoped for. It is not surprising therefore that in his closing statement, “There’s a fairly high degree of uncertainty about both the path and the ultimate destination of any further increase,” that markets declined into the close with the S&P 500 losing 1.5% on the day. This is a debate that will carry into the new year.
Another central part of the economy, the oil markets, could also be the root of some of the problems with the overall market. Oil is not only one of the most political assets, it is an asset class that touches everyone. The cost of energy, like the cost of capital, has a large influence on business and consumers decision making. The price of oil was highly volatile all year, giving rise to much confusion. Trading in a range from a high of $80 per barrel to a low of $36 per barrel, provided little direction for traders looking for energy to give them insight into the broader economy. During the first half of the year, rising prices led to fear that the economic benefits of tax reform would be wiped out for the consumer due to rising gas prices. After peaking during the Fall, declining prices subsequently led to fears that the oil market was signaling decelerating global growth. We learned back in 2016 that the energy sector is a large source of jobs in several parts of the country that are experiencing strong economic growth. The loss of those jobs would quickly threaten the broader economy and sectors such as housing and banking. The highly volatile price swings certainly contributed to the lack of confidence for many investors that look to the commodities sector to provide direction for the overall economy.
Now for the obvious, add to all of this: an unresolved trade war with China, and you can find your way to a negative year quite easily. It was assumed early on that our differences with China could be resolved in order to avoid any significant impact on the economy. As talks failed to progress and each side dug in to support their respective position, signs of the erosion of confidence began to appear. Psychology can have a huge influence on investor and consumer behavior. It should be no surprise therefore that economists pay close attention to the variety of measurements used to gauge consumer confidence. The December index of U.S. Consumer Confidence declined for the second consecutive month. The report cited concerns by consumers about the potential for slowing growth in the year ahead and volatility in financial markets around the world. It further noted, “continuing concerns about the Trump administration’s trade actions this year.” It is most definitely being seen in business spending decisions, where boardrooms have simply lost their visibility. Economists closely monitor order volumes as a signal of future demand. Orders for machinery, electrical equipment, motor vehicles and parts orders all fell in November. New orders for nondefense capital goods excluding aircraft, fell for the third month out of four.
As with so many other cross signals throughout the year, personal consumption expenditures did not match up with the idea of declining consumer confidence. The latest measure of household spending rose again, making it the ninth straight monthly increase in household outlays. The chief economist at Amherst Pierpont put this in a note to clients, “The consumer is on fire, and, I’m sorry, if the stock market is trying to signal that the U.S. economy is crumbling, Mr. Market is wrong.” The University of Michigan’s index of consumer sentiment rose in December as confidence in job and income prospects appeared to outweigh worries about financial markets. This could help to explain that despite all the market volatility during December, U.S. retail sales, excluding automobiles, rose 5.1% from the comparable period a year ago. This represents the strongest holiday sales increase in six years. This has led many to believe that it will be the consumer that will lead the economy in 2019. The personal savings rate, the difference between disposable income and spending, was 6% in November, the lowest monthly rate since March 2013. Strong spending and modest saving suggest consumers have felt confident in the recent months. This constant range of conflicting news helped to drive the volatility that dominated the markets for much of the year.
As we put 2018 behind us and look forward to another year, there were many significant events outside of the markets. We witnessed the first cloned primates, welcoming a set of monkeys to a laboratory in China. A U.S. company led by Elon Musk, successfully launched the worlds most powerful rocket with a Tesla Roadster on board. Not one, but two companies surpassed the trillion-dollar mark for the first time ever, Apple and then Amazon. The world watched in awe as another Royal wedding dominated the attention of every media outlet that could be there. We also said good bye to several very notable individuals including Barbara and George H. W. Bush. The entertainment world also lost Burt Reynolds, Aretha Franklin and Neil Simon. Among others, sports fans lost Rusty Staub and Roger Bannister, the first sub 4-minute miler and the business world lost Microsoft co-founder, Paul Allen.
Hopefully it was a good year in some way for each of you and may we all look forward to a happy and healthy new year!