2018 started nicely enough. But then it turned stormy. Almost all of our major indices were down in 2018. Most of the chaos happened in the last few months.
Paradoxically the US economy, and most of the global economy, continued to boom in 2018. U.S. corporations delivered astonishing growth, with earnings up some 20.5% according to FactSet. This was fueled in part by deregulation and 2017 tax changes. Job growth was similarly nothing short of astonishing. There have been about 3.8 million jobs created in 2017/2018, more than half in only five states: California, Texas, Florida, New York, and Georgia. Apparently 1.1 million of those jobs were added October 2017-October 2018.
Surprisingly, some communities of the US remain mired in a post 2008 recovery, and have experienced little improvement in quality of life for decades . And, of the 43 million Americans receiving social security, 62% rely on those monthly checks for at least 50% of their retirement income. In other words, the distribution of economic growth and income disparity are going to be giant issues going forward.
Nevertheless, in general, the economy in 2018 was stellar. For example, Americans bought 17.3 million new cars, the fourth consecutive record. It was a bumper year economically.
As a result, stock markets of the world, including that of the US, rose substantially early in 2018. Then, in the second quarter, President Trump initiated an angry trade war with the world, largely with China, from which foreign stock markets immediately recoiled.
Perhaps this trade war was inevitable. Led by hardware maker Huawei, state-owned Chinese technology firms have become so blatant in their thefts of American intellectual property, and in their capacity to conduct surveillance on Americans, that some response was necessary. It might be argued that the US government’s response was a sledgehammer to cope with mosquitos. But those mosquitos increasingly have the ability to bleed us dry.
Due to fears of an overheating economy, the United State’s central bank, the Federal Reserve, raised interest rates four times during 2018, to 2.5%. That’s still low by historical standards, but compared to the almost-zero rates of a few years ago, it was a steep enough rise to give bond markets the frights.
While this was happening, the Fed was also quietly allowing $355.5 billion of its government debt to mature without making new purchases. These bonds were the remnants of 2011’s Operation Twist, in which the Federal Reserve drove down longer term interest rates, causing the economy to grow and also causing some of the excessive corporate and private debt load we see today. This Fed action was probably more important than the interest rate hikes, because it reduced money supply, and implicitly reduced bond demand, allowing longer term rates to move up. As a result of these decisions, interest rates began to rise from market behavior as well as government actions. Mid year, our bond mutual funds were showing losses for the year.
Meanwhile nothing aside from great statistics and wage growth of about 3% appeared to suggest that inflation was about to run rampant. Inflation, after all, is one of the greatest destroyers of wealth. However, it stayed below 2% in 2018, in the United States. In comparison, apparently the inflation rate in Venezuela was over 1,300,000% in 2018, because of national collapse. So, yes, inflation CAN get out of control.
Meanwhile, in Europe, the economy continued to contract. One interesting note about the ongoing Brexit process…Great Britain exiting the European Union…is that the European Union isn’t that attractive an organization. Europe faces gigantic demographic, debt, governance, and trade issues. And, in 2018, their economy and often their stock markets struggled. Italy endured a budget crisis due to overspending in 2018, but the EU kicked that can down the road by essentially refinancing. There’s genuine discussion by serious analysts about the ability of several European states to repay their debt at all.
In fact, one of the big themes of 2018 was the surfeit of both private and government debt worldwide. My guess is that eventually we will have a reckoning, but that moment of truth may not happen for decades. Meanwhile the governments of the world are busy covering it up. In the short run this makes a recession more likely although the indicators suggest 2020 rather than 2019. And, of course, a recession may not happen in the immediate future, with slower growth the reality instead.
Interestingly the Chinese became net sellers of U.S. Treasury bonds in 2018, although they still own $1.14 trillion of our debt. My thought is that these sales happened because they’re worried about economic softness at home.
In July, the U.S. population recorded the lowest year-over-year growth rate, 0.62%, since 1937. Half the growth was from the surplus of births versus deaths. Half was from immigrants becoming U.S. citizens. 2017’s data tells us that U.S. women are having an average of 1.76 children, below replacement rates and the lowest since 1978. Holy Japanese demographics! The future looks very different.
The U.S. S & P 500 large cap index reached an all time high of 2931 on September 20th, 2018. It then fell 19% to the end of the year, which may or may not qualify as the 20% necessary to be a full-on bear market. Downturns like this usually take an average of 24 months to regain all-time highs. But that’s just an average. Meanwhile, global equities outside the U.S. plunged the most on a monthly basis since 2012. Outside the United States, most stock markets struggled.
In November, in the midst of much toxic division, Democrats regained the majority of the United States House of Representatives. Despite the alarmist and meandering rhetoric by both extremes, my experience has been that a divided Congress is often a better Congress because more useful compromise legislation is sometimes the result. The alternative – deadlock – is often better than one political faction running away with the government while creating debt and discord.
As stock markets declined sharply in late December, bonds played their traditional safe harbor role. Yields went down as bond prices went up, resulting in positive or at least neutral returns for many of our bond mutual funds for the year. And in the first week of December, the yield curve inverted very slightly, as the yield on the three year Treasury rose infinitesimally above the yield on the five year Treasury. That sometimes…but not always…signals a recession in coming months. To me, it didn’t seem like a very strong signal, and it didn’t last. But of course the media’s talking heads were all over it.
In expectation of a possible recession, which may or may not happen, oil prices declined sharply towards year end and gold rose slightly towards year-end. This meant that our asset allocation funds, which traditionally use energy stocks to offset inflation, did less well than normal in 2018.
The result of this wild ride was a down year for the financial markets in general.
Literally on the lowest day of the stock markets in 2018, December 24th, when the S&P 500 closed at 2351, I had three clients call to ask to liquidate. When clients call to liquidate, it’s a very positive sign. Fear tends to mark market lows.
To put all this in context, according to BTN Research, since 1950, the S&P 500 has been up 54% of 17,361 trading days, 60% of 828 months, 66% of 276 quarters, and 72% of 69 years. Since 1926, 84% of the rolling 3 year periods of the S&P 500 Index have produced a positive return.
In other words, history seems to be on our side. My plan for now is to stay the course, weed the garden, and buy bargains. Down markets are full of opportunity. I’ll spell out my thoughts for 2019 more deeply in my next newsletter in a few weeks.
I know that it’s hard to endure financial market turbulence with the life’s savings which is essential for your wellbeing. Nevertheless, turmoil is normal, and we’ve been here before! 2018 marked our 30th year, and in those 30 years we’ve experienced many twists and turns on the road to creating long-term financial success. Our patience has genuinely created wealth, hasn’t it? As a result of our ability to cope with, and even take advantage of, tough times, Andresen & Associates has grown to where we are today. We expect success in these uncertain times as well. Thanks for being our clients.