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Investment Outlook Fourth Quarter 2018 - Market Recap and Review

By: Tyler J. Smith
Wednesday, February 6, 2019

We are more than happy to put 2018 behind us, at least from a markets’ perspective.  December capped off what turned out to be the worst year for stocks in more than a decade.  All the major averages finished in the red, falling between four and seven percent.  Quite a change from the record-setting highs we saw back in September.  Moreover, stocks weren’t the only disappointments in 2018.  Even traditional safe havens like gold and bonds finished lower for the year.  Interestingly enough, fine art and wine were among the select few registered investment classes with positive returns (classic cars held in there up until the very end). 

2018 Market Returns

Index

4Q18

2018

S&P 500

-14.3%

-6.2%

Dow Jones

-12.9%

-5.6%

Nasdaq 100

-17.4%

-3.9%

Intmd Bond Index

1.1%

-1.4%


So, what happened?  The truth is, not a whole lot actually happened.  The issues of late have much more to do with what could happen. Sure, we saw the Fed hike short-term interest rates, there is ongoing turbulence in our relationship with China, and major technology companies face a looming possibility of tighter government regulation.  However, none of these things have translated into a meaningful change in the underlying fundamentals that were driving the markets higher only a couple months ago (i.e., GDP, consumer spending, corporate profits, etc.).  

Why, then, have markets taken such a hit?  There are endless possible explanations, but many have to do with the perception of control (bear with me).  It’s human nature – we all like the feeling of being in control and investors are no different.  For much of 2018 it was relatively smooth sailing.  Economic data was strong and there was little to keep people from buying the stocks of companies they liked.  These beliefs were reinforced as stock prices rose and little changed within the investment landscape.  The positive feedback loop created by this environment ultimately led to a greater sense of control across all investors.  However, when new variables were introduced, such as those mentioned above, it created uncertainty; and uncertainty is nearly synonymous with a loss of control.  

In order to alleviate uncertainty and regain our sense of control, we formulate theories/models/stories/estimates/etc. to help us make sense of new variables.  Given stocks had been doing so well, it was much easier to write a negative story for the future than it was to continue relying on the positives we knew to be true.  So, while none of us truly know if the recent rise in interest rates or the situation with China will lead to a major change in the economy, the fact we could create a compelling narrative for a way in which they could was all that really mattered.  

An unfortunate byproduct of this process is negative sentiment.  When negative sentiment lingers for too long, it has the potential to become a sort of self-fulfilling prophecy (i.e., markets go down for long enough, they themselves create the economic slowdown we feared).  We are not predicting this as our base case, but do acknowledge it as a possible outcome.  We actually fall more in line with those who remain encouraged by the strength of our underlying economy.  

So, how do we think about investing more specifically in this type of environment?  How do we maintain our sense of control?  It may sound like a broken record, but we do our best to take the long-term view and invest in those companies with solid business models and outstanding management teams.  This doesn’t make these companies immune to down markets, but it does increase the likelihood their stories won’t be derailed by times of economic stress.  

At the end of the day, try not to take all the negative headlines and rhetoric as gospel.  Instead, try to look at them as peoples’ attempt to account for changing circumstances and regain their sense of control.  This approach can make it much easier to stick to your long-term strategy by filtering out the noise that otherwise might have jeopardized your own sense of control.  Here’s to a healthy and prosperous 2019!  

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