“I have two kinds of problems: the urgent and the important. The urgent are not important, and the important are never urgent.” Dwight D. Eisenhower in a 1954 speech to the World Council of Churches, quoting Dr. J. Roscoe Miller, the President of Northwestern University.
December’s market swoon came as a shock for many investors. After finishing the previous nine years with a positive return, December’s market selloff resulted in the first negative annual total return for the S&P 500 since 2008. The fourth quarter of 2018 also marked the fourth time in the last decade that the S&P 500 declined more than 10% over the course of a quarter. The other three times occurred in Q1 2009 (-10.9%), Q2 2010 (-11.4%), and Q3 2011 (-13.8%). There were numerous factors that seemed to contribute to investors’ fear. Among them were increasing concerns about a slowing global economy, the ongoing trade war between the U.S. and China, the Federal Reserve disappointing markets by raising rates 25 basis points in December and signaling an additional two rate hikes in 2019, uncertainty surrounding the impact of falling oil prices, and fears that corporate earnings may have peaked. Adding “agita” to the markets were comments by current Chair of the Federal Reserve Jerome Powell that the Fed’s ongoing unwinding of its balance sheet would continue on “automatic pilot.” Throw in selling pressure from investors engaged in year-end tax-loss selling and a lack of buyers over the holidays and you have the perfect recipe for a significant market correction. By Christmas Eve, the S&P 500 was less than one-half percentage point from entering a bear market (traditionally defined as a drop of 20% or more). However, equities rallied back following a Christmas break to narrowly avert an official bear market. U.S. small-cap stocks fared the worst of the major equity asset classes, losing 20.2% during the fourth quarter and bringing their year-to-date losses to 11.0%. Losses were wide spread across all equity asset classes and market sectors with virtually all equity asset classes finishing both the quarter and the year in the red.
As investors fled volatility in equity markets, many sought to allocate their capital to the relative safety of bonds. This flight to safety helped push interest rates lower in December, driving the benchmark 10-Year Treasury down to 2.69%, 55 basis points below its peak of 3.24% on November 8, and only 29 basis points above where it ended 2017. Despite interest rates mostly rising throughout the year, the December rate plunge moved broad fixed income indices back to the breakeven point or slightly into positive territory for the year. The Bloomberg Barclays U.S. Aggregate Bond Index, the broad benchmark used by many fixed income investors, finished the year with a return of 0.01%, which would be about as low as you can go and still claim a positive return. Shorter/intermediate-term municipal bonds, measured by the Bloomberg Barclays Municipal Bond 5-Year Index, finished the year up 1.7% after a strong fourth quarter rally.
Despite the pervasive pessimism that seemed to overcome markets in the fourth quarter, there are more than a few bright spots to consider as we look forward to a new year. The U.S. economy grew at an annualized rate of 3.4% in the third quarter of 2018, and growth in China is expected to be in the neighborhood of 6% in 2018. Inflation continues to be benign, with the latest report showing the CPI (Consumer Price Index) rising 2.2% year-over-year through the end of November. The unemployment rate is also low, coming in at 3.9% as of the latest report from the Bureau of Labor Statistics on January 4. Low levels of inflation combined with a strong and apparently stable labor market should continue to provide a counter to some of the worst market fears. And it seems fair to posit that investors are pricing in some fairly negative outcomes related to tariffs, trade wars, and other geopolitical concerns. Given these positive underlying economic indicators, any upward surprise in the areas with which the market has expressed so much concern could significantly improve investor psychology.
As we move into a new year, investors should continue to focus on what is important, their long-term investment plan. The investment plan should include contingencies for changing market conditions, such as portfolio rebalancing, tax-loss selling, and reassessing the asset allocation of the plan as conditions change. But we should all beware of devoting too much time to the tyranny of the urgent, never letting it distract us from that which is truly important.