The final quarter of 2018 hit with a dramatic downturn for the stock market, while bond investments generally performed well. Large U.S. company stocks were down 13.5% over the quarter and down 4.4% for 2018. Small company stocks were down 20.2% this quarter and 11% on the year. Bonds were 1.6% higher for the quarter, though they were flat for the year.
The fourth quarter setback for stocks was abrupt and vexing. Large company stocks had recently risen 10.5% by the end of the third quarter. But by the year’s end, they were down 4.4% in a sharp reversal. Analysts have been reminding investors for years that a notable sell-off could arrive unexpectedly as the rising market endured longer and longer.
Back in September, economists were not worried about a fourth-quarter stock market slide. On the contrary, the Fed was contemplating at least 3 rate hikes in 2019 to temper rapid economic growth, and all systems were “go” in terms of economic forecasts. So, what happened?
Clouds gathered quickly amid signs of slowing global economic growth and the effects of the mounting trade war with China. Tensions resulting from the Trump administration’s confrontation with China have nurtured uncertainty among U.S. based multinational companies. Investors worry that a trade war will temper the outlook for multinationals, US farm exports, and even their domestic suppliers.
At quarter-end, the Fed announced an interest rate increase—the fourth for 2018—and at the same time, it announced a lowering of its 2019 growth projections for the U.S. economy. The Fed enacts rate increases when it believes the economy is growing and the rate of growth needs to be moderated order to sustain it. The markets didn’t like the double-whammy of higher rates (which tap the brakes on the economy) and lowered growth projections (forecasting a slowing economy). The result: the worst December stock market since the Great Depression. The president’s style of lurching from one crisis to the next served only to antagonize the situation and stoke concerns.
The rise in domestic stocks through September was supported by perceived benefits of the November 2017 Republican tax cuts. At Natural Investments, our investment committee doubted that the cuts—which primarily benefit corporations and the wealthy—would help the real, non-financial economy and most Americans. Reduced corporate taxes generated increased corporate profitability and propelled stocks higher through September. However, instead of investing in new production and hiring new employees, corporations invested much of this windfall into “share buy backs,” in which corporations buy their own shares to remove them from the market. Such buy backs create demand and reduce supply for company stock, thereby inflating stock prices and artificially increasing company per-share earnings—a metric Wall Street watches closely.
The tax cuts produced a “sugar high” of sorts for the stock market, which, if you’ve spent much time around children, you’ll know wears off quickly. Similarly, the stock market has now lost all gains, and then some, since the tax cuts were passed by congress and signed by the president in November 2017. Further, since taxes were cut but spending was not, economists are forecasting record federal budget deficits for 2019 and beyond.
While the stock market and government shutdown have ushered 2018 out on a gloomy note, the prevailing mood among many stock analysts is that of cautious optimism for the new year. Even though the political environment is likely to remain as contentious and exhausting as it has been for the last two years, most economic fundamentals remain positive, and stocks may bounce back in 2019. That being said, the stock market can act as a “leading indicator” foretelling economic slowdowns and even recessions. Another recession remains a possibility for 2019 even if more economic forecasts point to 2020 as the likelier scenario, which would be bad news for a sitting president.
