2018 Year-End Market Commentary

It’s amazing what a difference a year can make. In our 2017 year-end market commentary we reflected on a year with positive returns and very low volatility across nearly every investment class. Now we look back on 2018, which saw negative returns in just about every asset class along with a significant increase in volatility.

It was a roller coaster year for U.S. stocks as the S&P 500 got off to a hot start in January, only to drop by 10% in early February. The index then saw a steady rise from April through the summer months and hit new all-time highs in September. The decline started in October with a loss of almost 7%, followed by a brief 2% rebound in November. December closed out the year with a big decline of over 9%, leaving the total return for the S&P 500 for the year at negative 4%.

Large cap US stocks weren’t the only asset class to post negative returns on the year, and a loss of 4% doesn’t look bad compared to some other stock categories. Small cap stocks lost about 11% on the year as measured by the Russell 2000 and international developed company stocks lost over 13%, as measured by the MSCI EAFE index. Emerging market stocks, which led all asset classes with a 37% return in 2017, also led the way to the bottom in 2018 with a loss of about 15%.

You might not expect bonds to have been a safe haven in a year when the Federal Reserve raised rates four times, but the Barclay’s US Aggregate Bond index actually finished up 0.1%. Normally that wouldn’t be worth cheering for but compared to most other asset classes it looks pretty good. It also serves as a reminder of why we hold bonds in portfolios in the first place, even if we think rates might continue to rise. There were a few times this year when stocks and bonds both fell together, but in December, when the S&P 500 lost over 9%, the Barclay’s US Aggregate Bond Index finished up almost 2%.

If you want to get a sense for how much volatility spiked in 2018 compared to 2017, check out some of these stats from Ben Carlson on his blog “A Wealth of Common Sense”:

It’s safe to say 2018 and 2017 were like night and day. The question now of course is, where do we go from here? The answer, unfortunately, is the same as it was last year, and every year before that: we don’t know!

There are arguments to be made for a further decline in the markets in 2019 or a recovery and a year of positive returns. The economy is still growing with generally strong fundamentals and the latest jobs numbers were very good. Yet the ongoing trade war with China continues to weigh on the global economy and the US government shutdown to start the year will likely have a lasting impact.

The beauty of developing a long-term plan and sticking with it is that you don’t have to try to guess what the future will hold. At the end of 2017, when stocks were up over 20%, we were trimming stock allocations in portfolios. We did this because the strong returns pushed allocations higher than the targets we had set, not because we thought the market was due for a correction.

In hindsight this turned out to be a good move as stocks finished lower this year, but we don’t look back and judge our actions based solely on the result. Instead, we review the process we followed to make that decision and determine if we need to make any changes to that process. That process is to rebalance portfolios when they move too far from our target allocations. We believe that over the long-term this will benefit our clients, but it won’t always be immediately obvious as the right decision.

Right now, with stocks down, there are some portfolios where we need to rebalance and add back to stocks. If stocks see further declines in 2019 that might not look like the right move, but if we follow the right process, we feel confident it will prove to be the right move in the long-run.

In addition to regular rebalancing of portfolios, the recent sell off provided the opportunity to harvest capital losses for some clients, which offers a nice tax benefit in taxable accounts. It has also been a great reminder to many of our clients of what real volatility looks like when investing in stocks. Last year we suggested you think about how a 20% decline in the stock market might make you feel and how you would react. Now that we’ve experienced close to that level of decline (from the peak in 2018 to the bottom), you likely have a better answer to that question.

Now is a great time to reassess your long-term plan. If you don’t think you can stomach this kind of volatility in the markets, you need to see if your plan would work with lower investment returns. Risk and reward are correlated so if you want to take on less risk, you need to accept lower returns. If you can reduce your expenses or save more, you might still be able to make your long-term plan work, but as with all things in life there are tradeoffs.

Finding the right balance in both your investment portfolio and in your life is an important but difficult task. We are here to help you think through these tradeoffs and to help you find the right balance. Please don’t hesitate to reach out to us to discuss!

-Chris Benson, CPA, PFS