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Quarterly Summaries

2018 Quarterly Summaries

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Review of Securities Markets, Fourth Quarter, 2018

U.S. stocks had their worst quarter since 2008 as concerns about the pace of global economic growth increased. U.S. companies reported strong earnings growth for the third quarter, but many companies reduced earnings guidance due to softening demand and rising input costs resulting from trade tariffs and higher labor costs. Investors also became concerned that the Federal Reserve (Fed) may continue raising interest rates despite a slowing economy. As a result, the S&P 500 Index of large company U.S. stocks declined 13.5% for the quarter and ended the year down 4.4%, the first negative year for the index since the 2008 financial crisis.

U.S. small company stocks fell by wider margins during the fourth quarter as investors disproportionately sold off riskier assets. The Russell 2000 Index was down 20.2% for the quarter and down 11.0% for the year. Value stocks performed better than growth stocks during the fourth quarter mostly due to weakness in the technology sector. For the year, however, growth stocks led value stocks.

Foreign stocks outperformed U.S. stocks during the quarter but were also down sharply. The MSCI ACWI ex USA Index dropped 11.5% over the period and ended the year down 14.2%. Concerns about economic growth outside of the U.S. increased during the quarter, fueled by reports out of Germany and Japan that their economies had contracted during the third quarter. Additionally, the pace of economic growth in China also ticked lower in the third quarter. Concerns about the continuing negotiations over the terms of Brexit and Italy’s budget deficit also pressured foreign stock prices.

U.S. bonds rallied during the fourth quarter as investors sought the safety of U.S. Treasuries. The yield on the U.S. 10-year Treasury ended the quarter at 2.68%, down 40 basis points from the beginning of the quarter. The Fed increased the federal funds rate in December as expected but lowered the number of expected interest rate increases in 2019. The Bloomberg Barclays US Aggregate Bond Index rose 1.6% during the quarter, erasing losses from earlier in the year to end 2018 virtually flat. In terms of commodities, the Bloomberg Commodity Index declined 9.4% during the quarter and 11.3% for the full year. The price of oil dropped approximately 40% over the last three months of the year as production rose at the same time investors were reducing expectations of future demand. Prices of industrial metals such as copper and aluminum also declined due to expectations of lower global growth.

The best-performing portfolio asset class in 2018 was cash — the last time this was the case was 1994.

Should Old Acquaintance Be Forgot

It seems like a long time ago but it was only this past September when the S&P 500 was up over 10% for the year and making new all-time highs. Disappointing economic data, escalating trade wars, and concerns about Fed policy changed that situation quickly in the fourth quarter as stock markets across the globe declined. When all was said and done, diversified portfolios managed by B|O|S that had been showing gains through the first nine months of the year registered losses for the year as a whole.

One challenge for investors in 2018 was that virtually all of the individual country stock indices were down for the year. Considering the MSCI ACWI, which includes U.S. stocks as well as the stock markets of the other major countries around the world, only two of the forty-seven countries in the index, Qatar and Peru, generated positive returns in 2018. As such, the MSCI ACWI ended the year down 9.4%. Consequently, there was little benefit from diversifying stock exposures across countries.

Investment returns in 2018 highlighted one important limitation of diversification: when major stock indices decline sharply over short time frames, diversification among stocks often provides little benefit as correlations between the different categories of stocks (U.S. vs. foreign, value vs. growth, small vs. large) tend to increase. During these periods, the key diversification consideration is not what kind of stocks you own but instead how much stock you own relative to more conservative assets such as high-quality bonds. While global stocks fell nearly 10% in 2018, returns on high-quality, shorter-term bonds were modestly positive.

It can be helpful to keep last year’s stock market decline in perspective. Considering the 15 years prior to 2018, the S&P 500 had registered a loss in just one of those years (although that one year, 2008, was especially severe, with a loss of 37%). This recent period of annual gains is quite unusual. Going back to 1927, the S&P 500 had losses in roughly one year out of every four, on average. In other words, down years are a part of typical market cycles, and thus should be expected to occur with some regularity.

The dramatic turn in the markets in the last three months of 2018 is a good reminder of why it is important to prepare for tough markets before they happen and to position portfolios to withstand the inevitable storms that will occur over a long-term investment horizon.

Written by Jeffrey Blanchard, CFA, Investment Analyst; jeffrey.blanchard@bosinvest.com and Rich Golinski, CFA, Chief Investment Officer; rich.golinski@bosinvest.com

Quarterly Review of Securities Markets: Total Return

IndexMarketLast 3 Months2018
Standard & Poor’s 500Large Co. U.S. Stocks-13.52%-4.38%
Russell 1000 ValueLarge Co. Value U.S. Stocks-11.72%-8.27%
Russell 2000Small Co. U.S. Stocks-20.20%-11.01%
MSCI All-Country World ex U.S.Foreign Stocks-11.46%-14.20%
Barclays 1-5 Year Gov’t/CreditU.S. Shorter-Term Taxable Bonds1.46%1.38%
Barclays Aggregate BondU.S. Taxable Bonds (Broad-based)1.64%0.01%
Barclays 1-5 Year Muni BondU.S. Shorter-Term Tax Exempt Bonds1.10%1.77%
JPMorgan Global Ex-U.S. BondsHedged Foreign Bonds2.42%3.58%

Key Economic Indicators

  • The latest U.S. gross domestic product (GDP) figures (third quarter 2018) showed the economy growing at an annual rate of 3.4%. Consumer spending rose 3.5% and business spending held steady at 2.5%. Growth in inventories also had a positive impact as inventories had been drawn down due to higher demand.
  • The latest U.S. employment report (December 2018) showed higher-than-expected job growth. Nonfarm payrolls increased by 312,000 in December, which was almost double the number that was expected. The unemployment rate increased to 3.9%, mostly due to an increase in people actively looking for work. Wages grew 3.2% year over year, which was the highest growth rate since 2009.
  • U.S. inflation remains low and has softened slightly from prior readings. The latest Consumer Price Index (CPI) data (December 2018) showed an annual inflation rate of 1.9%. Core CPI (CPI less food and energy) rose 2.2% from a year earlier.
  • The Fed raised the federal funds rate in December for the fourth time in 2018, increasing the target range to 2.25%–2.50%. Fed members have projected two additional rate increases in 2019. The Fed has also continued to reduce the size of its balance sheet.
  • The Bloomberg Commodity Index declined 9.4% during the fourth quarter. The price of oil dropped 38% to $45.81 per barrel while gold increased 7% to $1,285 an ounce during the quarter and silver rose 6% to $15.45 per ounce.

Key economic indicators compiled by Jeffrey Blanchard, CFA, Investment Analyst; jeffrey.blanchard@bosinvest.com

Disclosures:

The information presented within is for informational purposes only and is not intended to be used as a general guide to investing or financial planning, or as a source of any specific recommendations, and makes no implied or express recommendations concerning the manner in which any individual’s account should or would be handled, as appropriate investment or financial planning strategies depend upon the individual’s specific objectives. It is the responsibility of any person or persons in possession of this material to inform himself or herself of and to seek appropriate advice regarding, any investment or financial planning decisions, legal requirements, and taxation regulations which might be relevant to the topic of this report or the subscription, purchase, holding, exchange, redemption or disposal of any investments.

The portfolio risk management process includes an effort to monitor and manage risk, but does not imply low risk. Past performance is not indicative of future results, which may vary. The value of investments and the income derived from investments can go down as well as up. Future returns are not guaranteed and inherent in any investment is the potential for loss.

This report does not constitute a solicitation in any jurisdiction in which such a solicitation is unlawful or to any person to whom it is unlawful. Moreover, this report neither constitutes an offer to enter into an investment agreement nor an invitation to respond by making an offer to enter into an investment agreement.

Opinions expressed are current opinions as of the date appearing in this material only and are subject to change. No part of this material may, without the prior written consent of Bingham, Osborn & Scarborough, LLC, be (i) copied, photocopied or duplicated in any form, by any means, or (ii) distributed to any person that is not an employee, officer, director, or authorized agent of the recipient.

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