2018 Review and Outlook for New Year .

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2018 Review and Outlook for New Year

Executive Summary:

  • The major U.S. equity indices had their worst annual performance since 2008.
  • Only two of eleven GICS sectors, healthcare and utilities, finished 2018 in the green.
  • Long treasury yields spiked to new multi-year highs to start Q4, but finished sharply lower.
  • Global PMIs are falling meaningfully with China’s dropping into contraction in December.
  • Four rates hikes, QT, and mixed messages by the Fed are reducing liquidity and confidence.
  • China trade wars, a pending Brexit vote, and a government shutdown are just a few of the many geopolitical concerns impacting markets and sentiment.


Following 2017, which saw strong gains in asset prices and record low volatility, 2018 was anything but calm.  After eight daily S&P 500 moves of 1% or more in 2017, there were 64 such moves in 2018.  2018 started off with explosive growth with the S&P 500 registering its strongest January (+5.6%) in 21 years.  This is typically a bullish signal for the rest of the year, but volatility came roaring back in early February following a higher than expected average hourly earnings report.  This led to fears of a more hawkish Fed and within two weeks we saw double digit declines in all major equity indices.  Over the next two plus quarters indices recovered all of those losses and then some, however they were accompanied by meaningful divergences in both breadth and momentum, amidst a backdrop of slowing global growth.    

At its January 2018 highs, 34% of the members in the S&P 500 index were making fresh 52-week highs.  However when the index returned to new highs in August and September, just 12% of the members were making new highs.


Momentum was meaningfully lower in August and September as compared to January with the weekly RSI (lower panel) reaching an extreme “overbought” 90 reading in January but then peaked at just 68 in August and September despite price making new highs. 


The Dow was the last of the major equity indices to return to new highs in late September, but what followed next was the worst quarterly performance since the Great Recession in Q4’08.  With Q4 being a seasonally bullish time of year, Q4’18 was the third worst Q4 for the S&P 500 (-14%) since 1950, outdone only by 2008 (Great Recession) and 1987 (Black Monday).     

The past year marked the first time since 1978 that the Dow finished with an annual loss after rising in the first three quarters, and the first for the S&P 500 since 1948. For Nasdaq it was only the second time in its history it failed to defend January-to-September gains through the end of the year.  The last time occurred in 1987, according to the Dow Jones Market Data group.

All major equity indices finished 2018 in the red and for most it was their worst annual performance since 2008.  The smaller cap stocks were hit the hardest with the Russell Microcap and Russell 2000 (small cap) indices declining 14% and 12.2%, and the S&P 400 Midcap index declining 12.5%.  Large caps fared better with the S&P 500 and Dow Jones Industrials declining 6.2% and 5.6%.  The Nasdaq Composite and 100 indices were the relative outperformers with modest declines of 3.9% and 1%. 

Fitting the technical definition of a bear market, the Russell Microcap and Russell 2000 indices declined 29% and 27% from their 52-week high, followed then by the S&P 400 and S&P 500 indices with declines of 24% and 20% from their highs.  The Dow Jones Industrials came in just shy of a “bear market” with a 19% decline from its 52-week high.  

Sector Performance:


The only healthy sector wasHealthcare which finished comfortably in the green for 2018. The S&P 500 Healthcare Index (S5HLTH) gained +4.7% in 2018 for a total return of +6.5%. The only other sector to see a positive return for the year was the defensive Utility sector posting a 0.5% gain and a total return of 4.1%. The S&P 500 Index declined -6.2% for 2018 with the bulk of the damage coming in Q4’18 with a 14.3% price drop, which compares to a 9.6% decline for the S5HLTH.  For longer term healthcare investors, the sector is up over 110% since the 2013 lows.

Retail Strength in a weak market: Retail stocks had a strong 2018 (relatively). The S&P 500 Retail Sub-Index (S5RETL) gained over +12.5% for the year despite a 20% decline in Q4. The broader based S&P 500 Consumer Discretionary Index (S5COND) closed essentially flat for 2018 while declining 16.5% in Q4’18. On the flip side, Consumer Staples (S5CONS) only declined -6% in Q4, making it one of the better performing sectors for that quarter. For the year, the S5CONS saw a decline of -11.2% on a price basis and posted a negative total return of -8.4%. To put these moves into perspective, on 10/1/18, the S5RETL was up over +40% for the year, the S5COND was up nearly +20% and the S5CONS was down -5.5% for the year! Consumer spend is an important factor in U.S. GDP and any signs of strength there should be viewed as a positive for the economy. Q4’18 consumer spend is expected to top $1.1 trillion dollars, a ~+5% increase year-over-year.

2018 was anything but dull for the Technology sector. A top performer and market driver for much of the bull market, technology came back to earth beginning September of 2018 after being up 19.5% through the first three quarters of the year. A number of different factors plagued the sector ranging from potential increased regulation on social media platforms, to demand and cost concerns associated with the trade war with China, to earnings short falls and profit taking. One theme that was prevalent in all technology sub sectors during the 4th quarter of 2018 was de-risking.

In addition some of the highest valuation companies are in the technology space, and thus were susceptible to de-risking and profit taking.   That said while the Q4 decline was a steep 17.7% for the S&P 500 technology index, the YTD decline was a relatively modest 1.6%.  This highlights the significant gains the sector gave up in the final quarter of the year. 

As investors worried about macro factors such as a global economic slowdown, rising long rates, an unpredictable Federal Reserve and an unresolved trade war with China, they shed riskier assets in favor of safe havens.  Utilities (+0.5% in Q4), REITs (-4.6%) and Consumer Staples (-6.0%) outperformed compared to the double-digit losses for Energy,Materials, Industrials, Financials, Discretionary and (heavily tech weighted) Communications Services stocks.  There really was no good place to hide.  Sector differentiation mattered less as investors sold stocks for macro reasons.  The S&P 500 had 28 days with a 1% or greater move vs. only one in Q3 and sector correlations rose sharply in Q4 demonstrating that stocks moved more in lockstep. 

Energy was the worst performing sector in 2018 with the S&P 500 Energy Index declining 20.5%.  In Q4 alone it declined 24.4% as the underlying commodity, WTI crude, experienced a 45% decline from early October to its lows on Christmas Eve.  Markets appeared to be caught off guard in early November when the Trump administration granted select waivers for purchasing Iranian oil.   The strong dollar was an additional headwind, however the extensive decline within the quarter appears to also be reflecting the sharp global slowdown, particularly in China. 

Why the corrections? 

With robust corporate earnings and strong economic data, the strength and duration of the decline was somewhat of a headscratcher to most.  In the weeks ahead of Q3 earnings, consensus earnings growth expectations were +20%.  However S&P 500 earnings blew that away with a blended earnings growth north of 25%.  This marked the third straight quarter of 20%+ growth and the highest S&P 500 earnings growth since Q3 2010.  And while the last two GDP reports came in at a robust +4.2% and +3.5%, markets being forward looking mechanisms seemed more concerned with the notion that we have  moved “past the peak” in the cycle.  YoY U.S. economic and corporate earnings growth comps are expected to decline from elevated levels in 2019 as both periods will include the benefits of the U.S. tax reform.       

Fear of a hawkish Fed was a theme that returned in early October when Powell said rates were far from normal, and thus was arguably the catalyst that started the ball rolling for declining asset prices.  However there was a laundry list of other concerns contributing to the volatility and correction. 

One of the biggest and still ongoing overhangs has been the global economic slowdown.  The global manufacturing PMI finished at a 27-month low of 51.5 in December, down from 52 in November.  David Hensley, Director of Global Economic Coordination at J.P. Morgan, said: “The December PMI surveys signaled that the global manufacturing sector ended 2018 on a subdued footing.  Output growth remained stubbornly low, rates of increase in new orders and employment slowed and international trade flows deteriorated. The outlook also remains relatively lackluster, as business confidence dropped to its lowest level in the series history.”

A major concern has been the ongoing trade war between the U.S. and China.  The late November G20 meeting provided a 90-day reprieve from a 10% to 25% increase in tariffs on $200B in Chinese exports.  This also delayed a formal announcement on new tariffs on the remaining $255B in goods, and included an apparent agreement for China to increase purchases of U.S. agriculture, industrial, energy and other goods.  Markets initially responded favorably but the euphoria did not last long as the communication by both sides was conflicting, and more importantly markets recognized the bilateral structural issues between U.S. and China will be a very difficult gap to close in short order.  Core issues such as IP protection and technology transfer, along with structural issues related to China’s state driven policy, remain significant. 

With the S&P 500 close to the 2,800 level in early December, an unexpected curveball was thrown the markets way with the arrest China tech giant Huawei’s CFO.   This inflamed the elevating economic and technological confrontations between the world’s two largest economies, and hopes for a trade resolution began to diminish.  Already China’s Shanghai Composite declined more than 31% in 2018 reflecting the slowdown in its economy.  In the latest reading, China’s manufacturing activity contracted for the first time in over two years with its PMI declining to 49.4 in December from 50 in November.  Analysts were expecting a decline to 49.9. 

Europe had its own host of economic and geopolitical risks throughout late 2018.  The German economy contracted in Q3 for the first time in over three years as global trade disputes weighed on their export driven economy.  German GDP declined 0.2% QoQ in Q3 vs. expectations of +0.1%.   The German economy provides nearly 1/3 of all Eurozone output.  The Eurozone Manufacturing PMI data declined to 51.4 in December from 51.8 in November, the lowest since early 2016.  Elsewhere, U.K. Prime Minister Theresa May postponed the Brexit vote as there was little confidence in its passage.  Rome and Brussels finally came to terms on a budget deficit, while France was dealing with social unrest sparked from an attempt to increase gasoline taxes with seemingly deeper roots in the wealth gap between the upper and lower classes.


Central Banks:

Despite the economic slowdown and rising geopolitical risks, the ECB announced the end of its EQE asset purchase program at its December 13th policy meeting.  The plan was well telegraphed and not doing so may have created more concern than not. 

A week later on December 19th the FOMC hiked rates a fourth time in 2018 and the 8th time since December 2016.  The hike was widely expected despite the Q4 market turmoil and falling measures of inflation.  In similar fashion to the ECB, the move was telegraphed well in advance and not hiking rates would have arguably caused more concern than not.  However markets did not respond favorably to the accompanying statement and Q&A which was widely criticized and at the very least confusing with Powell’s previous comments made in October and November.  The FOMC reiterated its willingness to hike rates above neutral as long as economic data permits, and at the same time lowered its 2019 rate hike forecast to two from three.  Markets have already erased nearly all expectations for another hike in 2019.  The current probability for one hike is 6%, down from 75% just one month ago. 

Powell seemed less flexible regarding its “unprecedented” balance sheet reduction program and seemed to indicate it had little measureable impact on markets.  After holding steady around $4.5T for three years since January 2015, the balance sheet has declined nearly 10% to 4.08T throughout 2018.  Prior Fed leaders argued the purpose of QE was to provide liquidity and support asset


The U.S. dollar index rebounded from its worst annual performance in 13 years by gaining 4.4% in 2018 compared to 2017’s decline of 9.9%. The strong U.S. economy, diverging central bank policy, wide rate differentials, and safe haven status helped attract flows to the detriment of large multi-national corporations as well as economies with high levels of dollar denominated debt.    

Long yields made fresh multi-years in 2018 with the 10-year treasury yield’s move above the prior highs of 2013 and 2014 at the 3% - 3.05% range, to its 2018 high of 3.25% made in October.  After a retest of the 3.05% breakout in late October, the long yield attempted a move to new highs but failed again at 3.25%.  The ensuing move lower has been swift with the 10-yr yield ending 2018 at 2.68%.


The short end of the curve spent most of 2018 rising faster than the long end and thus the 2yr-10yr spread flattened to its narrowest spread in a decade.  The spread continued to decline along with the recent drop in rates and on an intraday basis bottomed at single-digit basis points in the days following the December FOMC. 

Looking Ahead:

Global indices were seemingly ahead of the now established weakening and in some areas contracting economic data within many of the world’s largest economies.  And while the U.S. has been the lone bright spot, many believe it is only a matter of time before the slowdown washes up on our shores.  The decline in asset prices seems to indicate that process began in Q4 and over the next one to two quarters we should expect the economic data to deteriorate, and the corrective, volatile price action to continue.    

From a glass half full perspective, many global assets, including a brief spell for the S&P 500, are already in a bear market, and by the time the remaining few get on board, it is very plausible the global recovery will already be underway.  The timing of which largely depends on the outcome of future events such as the trade war with China and the looming U.S. government shutdown.  Also, there is policy risk from the Federal Reserve whose multiple rate hikes and largely unprecedented QT program may be having a more significant impact on liquidity, valuations, and the economy than what policy makers are seeing. 

From a technical perspective we have seen readings that have previously accompanied market lows and thus may suggest we are at or close to bottoming now.  The Russell 3000 comprises 98% of all listed U.S. companies and on December 24th 42% of its members made a new 52-week low.  Outside of October and November 2008 which represent the peak fears of the financial crisis, this is the worst reading going at least as far back as the start of 1995.


Also on December 24th Just 9% of the index was trading above its 200-day simple moving average (sma).  This is the second lowest reading since the financial crisis, eclipsed only by October 3rd 2011 which then marked that year’s closing low and a decline of 22%. 


And finally the Russell 2000 made its 2018 low on December 24th and at that time finished down 21% from its 200-day sma.  This was the second largest discount to its 200-day sma since the financial crisis.  The largest discount occurred on October 3rd 2011 which then marked the 2011 low in price. 


The information contained herein is provided for informational and educational purposes only, and nothing contained herein should be construed as investment advice, either on behalf of a particular security or an overall investment strategy. All information contained herein is obtained by Nasdaq from sources believed by Nasdaq to be accurate and reliable. However, all information is provided “as is” without warranty of any kind. ADVICE FROM A SECURITIES PROFESSIONAL IS STRONGLY ADVISED.

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