4th Quarter 2018 Update

January 17, 2019

Key Points

• Analysts point to several factors causing volatility and lower prices during the quarter, including fears of a recession in 2019, lower corporate earnings growth and FOMC aggressiveness in raising interest rates.
• Equity markets took it on the chin during the quarter, posting the largest quarterly decline since the fourth quarter of 2008
• The Federal Open Market Committee (FOMC) continued its interest rate policy by raising the federal funds rate target 25 basis points to a range of 2.25% to 2.50%.
• The US economy continues a solid trajectory, fueled by last year’s tax cuts and an increase in government spending.

The Global Economy

The US economy continued to deliver robust gains in the third quarter. The Bureau of Economic Analysis reported its third estimate of third quarter 2018 gross domestic product (GDP) of 3.4%, in line with the prior estimate of 3.5%, but lower than the second quarter’s 4.2% reading. The employment situation slowed somewhat, but continued to deliver gains, with an average of approximately 170,000 jobs added each month. At the same time, the unemployment declined to 3.7%. The Federal Open Market Committee (FOMC) continued its interest rate policy by raising the federal funds rate target 25 basis points to a range of 2.25% to 2.50%.

The global economic environment has weakened slightly and remains volatile in the emerging economies. The reasons for the slowing are attributed to the US’s trade war with China and the tightening of monetary conditions domestically. The Eurozone economy suffered somewhat due to trade effects, but also because of a greater-than-expected slowdown in consumer spending.

Below, we’ve highlighted broader market returns for the 4th quarter and year-to-date time periods:

Source: Thomson Reuters

Fixed Income

Questions about the future health of the economy, the FOMC’s decision to raise short-term interest rates once again at its September meeting, and President Trump’s public displeasure with FOMC Chairman Jay Powell were a few of the drivers impacting the bond market during the quarter. In addition, even though job growth tailed off somewhat in November, it still remains robust, with unemployment at historically low levels. Wages have also been trending higher, which is usually a precursor to higher inflation, something the FOMC is willing to accept, but only up to a point. Most analysts, and the FOMC itself, expect there will be two more rate increases in 2019.

Equities

Equity markets took it on the chin during the quarter, posting the largest quarterly decline since the fourth quarter of 2008. There was no “Santa Claus rally” this year, as stocks also suffered their worst month of December on record, despite also generating the largest single-day point gain in history on December 26. Analysts point to several factors causing the volatility and lower prices, including fears of a recession in 2019; FOMC aggressiveness in raising interest rates; Democrats taking back the House of Representatives in the mid-term elections; and President Trump’s publicly expressing displeasure with FOMC Chairman Jay Powell.  All of these conspired to spook investors into taking profits earned as part of the longest bull market in history. During the quarter several broad-based indexes declined more than 20% from their respective peaks, a widely cited threshold indicating those indexes are in a bear market. Within this landscape, the S&P 500 Index finished the quarter with a decline of -13.5%, and posted a total return of -4.4% for 2018.

Summary

The US economy continues to generate reasonably strong growth, fueled by last year’s tax cuts and an increase in government spending. These fiscal stimulants have enabled the economy to grow at roughly a 3% rate in 2018, and have contributed to the addition of about two million jobs during the year. The consensus among economists is that the trend is likely to continue into 2019, albeit at perhaps a slightly lower rate of below 3%. Analysts expect employment gains to continue as well, enough that the unemployment rate should drop to around 3.5%. The FOMC is also expected to continue raising rates, somewhere between two and four 25 basis point increases, with the number depending on the strength of the economy at the time.

As we head into 2019, there are a number of risks of which investors should be mindful, including the ongoing trade war with China, which so far has not done significant damage to the economy. However, if it were to escalate, the adverse impact would be more consequential. Another risk is the outcome of the UK’s “Brexit” negotiations with their European counterparts. Most analysts believe the UK will come to an agreement that will ultimately have little impact on the US economy, but until it is finalized there is likely to be some volatility as a result.

Information provided is for informational purposes only and should not be construed as investment advice. The views expressed are current only as of the publication date, are based on information that St. Clair Advisors believes to be accurate, and subject to change without notice. All investment decisions must be evaluated as to whether they are consistent with your investment objectives, risk tolerance and financial situation. St. Clair disclaims any liability for any direct or incidental loss incurred by applying any of the information in this publication. Indexes are unmanaged and one cannot invest directly in an index. Past performance is no guarantee of future results.

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