Fourth quarter capital markets experienced extreme volatility, despite having a backdrop of positive economic fundamentals. While corporations marched on with impressive earnings reports of over 20%, the day-to-day market pricings did not reflect this strength. Wages continued their modest increase, but not at a rate to signal inflation con-cerns. Major economic indicators, such as job growth, manufacturing and consumer spending, continued to grow during the fourth quarter. Heightened uncertainties created an environment for increased market worries, including concerns about the Fed’s interest rate hikes, enhanced trade tensions with China, and an in-creasingly strident political tone. These factors led the market into a fourth quarter correction that was significant enough to erase the gains on the year in both the stock and bond markets. For the 4th quarter, major stock indices declined about 14%, while the bonds were flat. This brought the calendar year 2018 results for stocks down 6.25% and for bonds down 2%.
As of this writing, economic growth measured by GDP (Gross Domestic Product) is estimated to come in at 3.0% for 2019. Traditionally, this is the bench-mark indicator that the economy is strong and in expansion mode. The U.S. job markets reported fantastic em-ployment numbers in December, with the Labor Department showing employ-ers added the most jobs in 10 months. Also, the leading manufacturing index, ISM (Institute for Supply Management), rose to 59.7%, the second highest for the year. Anything over 50% signals com-panies are expanding and not shrinking. As expected, the Federal Reserve imple-mented a .25% interest rate hike at its meeting in December. The Fed also signaled a more dovish tone for 2019, indicating it may pause its previously stated hike schedule. The CPI (Consumer Price Index) is expected to remain steady, indicating inflation is not a near-term threat. The shift in the House of Representatives to Democrat control has led to a political stalemate. Historically, markets respond favorably to gridlock. Trade tariff talks with Chi-na seem to be moving forward, as both sides have recently indicated positive steps toward reaching an agreement.
The fourth quarter began with vol-atility, some of which came from scheduled yearly rebalancing of mutual funds and other index products. This volatility was exaggerated in the short term when the market has more sellers than buyers. Both the S&P 500 and the Dow Jones Industrial Averages experienced wider daily swings. This caused stock prices to act irrationally, aswell as increased short-term trading swings, and great company stocks were punished during the volatility. This was also reflected in the lowering of P/E (price to earnings) ratios, which pro-vide relative and historic stock value comparisons. Stocks have, as many noted analysts have stated, gone on sale. There was some sector rotation as Healthcare stepped ahead of Technolo-gy to finish out the year. Technology, while still extremely strong, has been susceptible to the China trade tensions due to its international nature. Energy sector stock prices were further sup-pressed by an October drop in crude oil prices. Going into 2019, Energy and Healthcare appear to be among the most attractively positioned sectors, with technology providing good value.
Due to the vital trade relation-ships between the world’s two largest economies, the comple-tion of the negotiations might provide a strong impetus to the market. They may also wrap up quickly as China’s econo-my shows clear signs of cooling down. As previously mentioned, the Fed has now indicated it may pause its rate hike schedule. We expect the economy to continue to expand, but at a more mod-est pace. Most encouragingly, however, the economy’s basic fundamental indi-cators show continued strength. In the face of short-term volatility, prices al-ways reconnect with fundamentals over the long-term.