Fourth Quarter 2018: The Bull Gets Trampled
The bull market that began in early 2009 finally lost its legs in the fourth quarter. The S&P 500 fell nearly 20% from September highs, finishing the full year in the red for the first time since 2008. Misery loves company, and markets in 46 out of the 47 countries classified as developed or emerging by MSCI declined in the year. The average country posted a 15% decline while the one outlier, Qatar, posted a 25% gain. While the magnitude of equity market drawdowns is significant, it is important to note that it comes on the back of broad market advances. Even after the correction, the S&P 500 is back to where it was just 15 months earlier in September 2017.
The Federal Reserve hiked rates four times in 2018, lifting the top range of the federal funds rate to 2.5%, and official projections show two to three rate hikes in the coming year. The markets, however, are skeptical and have priced in only a 10% chance that the FOMC hikes rates again in this cycle. Fed Chair Powell, like his predecessor Janet Yellen, is learning on the job about how best to communicate the rationale for future rate decisions, a job further complicated by President Trump’s public criticism of the latest tightening. The confusion over future rates and political uncertainty pushed long-term Treasury yields lower in the fourth quarter, flattening the yield curve. 10-year Treasurys offer only 30 basis points of incremental yield compared to 2-year bonds.
Traditional diversifying assets didn’t provide much relief for investors for the year as commodities and global real estate declined on growing global growth and trade war concerns. Oil dropped significantly as crude prices once again dipped below $50 a barrel. The decline in commodity prices has helped to drag market-based inflation expectations and inflation-protected Treasurys lower as well.