2018 ended turbulently, with equity markets declining over the last three months of the year. Since reaching a September high, the major U.S. stock indices approached bear market levels, defined by declines of 20-25%. Daily price swings were, and continue to be, dramatic. Suffice it to say, the calm market of 2017, which exhibited extremely low volatility, has left the building.
At Clifford Swan, we’re hesitant to allow news headlines to provide overly simplistic explanations of market moves. While some investors attempt to trace stock market movements directly back to certain political events or economic pressures, the causes are usually much more nuanced, with multiple factors at play. This time around, we note a few key influences. The first is interest rates. Globally, we have been in an extended period of low rates. The Federal Reserve continues to gradually normalize rates to higher levels by raising the federal funds rate (the overnight interest rate at which banks lend to each other) and is slowly shrinking its massive portfolio of assets purchased during the Financial Crisis. While the Federal Reserve’s actions have been widely anticipated, the stock market reacted negatively during the quarter to the Fed’s signaling for more potential rate increases in 2019.
A volatile news cycle may also be impacting the markets. From the government shut down and political stalemates, to trade tensions and perhaps slowing growth in China, investors suddenly seem keenly aware of potential risks. Despite this, we reaffirm our view that the U.S. economy itself remains strong. We do not foresee an economic recession. Inflation seems to be in check, and the labor market continues to tighten. Boosted by tax reform, corporate earnings growth had a record year in 2018. While earnings are expected to continue to grow, that growth is forecasted to slow, returning to levels that are more normal.
Finally, algorithmic trading (automated trading where computers execute a set of instructions) may also be part of the picture, as more and more invested funds are not only tied to passive strategies but to those that are programmed to trade into, and perhaps exacerbate, volatility. At Clifford Swan, we clearly take a different approach. We use fundamental analysis to consider investments individually. While market declines and corrections are certainly unpleasant, they have a silver lining of driving speculators out and creating value for investors. As active managers with a long-term focus, periods of moving prices allow us to hone our discipline and search for companies that, in our view, may be incorrectly priced. In other words, we get a chance to filter out the noise and do what we do best—invest prudently for the long term.
We urge our clients to remain calm and stay the course. Short-term corrections are unfortunately part of the price we pay for long-term growth. For context, the S&P 500 Index remains up over 280% since its bottom in March of 2009, despite four other declines of 10% or more along the way, as of our writing.
The above information is for educational purposes and should not be considered a recommendation or investment advice. Investing in securities can result in loss of capital. Past performance is no guarantee of future performance.
