Annual Market Review

Annual Market Review

Annual Market Review 2018

ANNUAL MARKET REVIEW 2018

Overview

Trade wars, midterm elections, and market volatility highlighted 2018 for investors. In an attempt to reduce the trade deficit, President Trump pushed to rewrite trade agreements with several long-time trade partners of the United States. Trump amended the trade agreement with South Korea, imposed tariffs on steel and aluminum, and renegotiated the North American Free Trade Agreement (now called the United States-Mexico-Canada Agreement). But the trade war with China has been the most compelling and impactful, not only to the countries directly involved, but to much of the global economy. Reciprocal tariffs were imposed by each economic giant throughout the year. There was a temporary truce achieved following the Group of 20 summit, but there was no definitive agreement reached.

Elections in November showed how politically divided the nation is. Democrats picked up 40 congressional seats to win control of the House of Representatives for the first time since 2011. On the other hand, Republicans maintained control of the Senate. The end result is a Congress that has become more divided, at least politically. Further, the federal government partially shut down in late December due to a budgetary stalemate between President Trump and Congress, principally over funding for a border wall.

For the year, the stock market reached new highs and gave it all back by the end of December. “Volatility” is the word that best describes the market late in 2018. Despite the economy expanding at a rate not seen in many years, favorable corporate earnings reports, strong consumer spending, tepid inflation, and plenty of jobs to be had, stocks fell. China trade, increasing interest rates, falling oil prices and geopolitical tensions were concerns. The Chicago Board Options Exchange (CBOE) Volatility Index (VIX), which provides a measure of market risk and investors’ sentiments, spiked in February, then was relatively stable through much of the summer. However, by the end of December, the VIX jumped again. Stocks were sold, bought, and sold again in rapid order, causing benchmark indexes to post noteworthy gains and losses on an almost daily basis in the fourth quarter.

The year saw some positive highlights as well. The economy expanded at an annual rate exceeding 3.0% for the first time in several years. The unemployment rate hit the lowest mark since 1969. In November, 1.7 million persons were marginally attached to the labor force, an increase of 197,000 from a year earlier. The Federal Reserve, based on the strength of the economy and labor market, raised interest rates four times during the year. Consumer income rose and purchases increased, and inflation exceeded 2.0% midyear, only to fall back below that target by the end of 2018.

Market / Index 2017 Close As of 9/28 2018 Close Month Change Q4 Change 2018 Change
DJIA 24719.22 26458.31 23327.46 -8.66% -11.83% -5.63%
NASDAQ 6903.39 8046.35 6635.28 -9.48% -17.54% -3.88%
S&P 500 2673.61 2913.98 2506.85 -9.18% -13.97% -6.24%
Russell 2000 1535.51 1696.57 1348.56 -12.05% -20.51% -12.18%
Global Dow 3085.41 3121.54 2736.74 -6.81% -12.33% -11.30%
Fed. Funds 1.25%-1.50% 2.00%-2.25% 2.25%-2.50% 25 bps 25 bps 100 bps
10-year Treasuries 2.41% 3.06% 2.68% -31 bps -38 bps 27 bps
Market/Index DJIA
2017 Close 24719.22
As of 9/29 26458.31
2018 Close 23327.46
Month Change -8.66%
Q4 Change -11.83%
2018 Change -5.63%
Market/Index NASDAQ
2017 Close 6903.39
As of 9/29 8046.35
2018 Close 6635.28
Month Change -9.48%
Q4 Change -17.54%
2018 Change -3.88%
Market/Index S&P 500
2017 Close 2673.61
As of 9/29 2913.98
2018 Close 2506.85
Month Change -9.18%
Q4 Change -13.97%
2018 Change -6.24%
Market/Index Russell 2000
2017 Close 1535.51
As of 9/29 1696.57
2018 Close 1348.56
Month Change -12.05%
Q4 Change -20.51%
2018 Change -12.18%
Market/Index Global Dow
2017 Close 3085.41
As of 9/29 3121.54
2018 Close 2736.74
Month Change -6.81%
Q4 Change -12.33%
2018 Change -11.30%
Market/Index Fed. Funds
2017 Close 1.25%-1.50%
As of 9/29 2.00%-2.25%
2018 Close 2.25%-2.50%
Month Change 25 bps
Q4 Change 25 bps
2018 Change 100 bps
Market/Index 10-year Treasuries
2017 Close 2.41%
As of 9/29 3.06%
2018 Close 2.68%
Month Change -31 bps
Q4 Change -38 bps
2018 Change 27 bps

Chart reflects price changes, not total return. Because it does not include dividends or splits, it should not be used to benchmark performance of specific investments.

The Economy (through November 2018)



The U.S. labor market was solid throughout 2018. Employment growth averaged 209,000 new jobs per month in 2018, compared with an average monthly increase of 174,000 new jobs in 2017. The unemployment rate ended the year (as of November 2018) at 3.7% — lower than the 4.1% rate at the close of 2017. Over the year, the unemployment rate and the number of unemployed persons declined by 0.4 percentage point and 641,000, respectively. According to the Bureau of Labor Statistics, there were 6.0 million unemployed persons in November 2018, down from 6.6 million unemployed in November 2017. The labor force participation rate was 62.9% in 2018, up slightly from last year’s rate of 62.7%. The employment to population ratio was 60.6% (slightly better than 60.1% in 2017). In 2018, the average workweek was 34.4 hours (34.5 hours in 2017). Average hourly earnings in 2018 were $27.35, an increase of 3.0%, or $0.80, over $26.55 in 2017.



Economic growth, as measured by the gross domestic product, expanded throughout the year, increasing at an annual rate of 3.4% in the third quarter of 2018. The first-quarter GDP rose 2.2%, followed by a 4.2% gain in the second quarter. Gross domestic product essentially measures what the economy produces, such as goods and services. On the other hand, gross domestic income measures all income earned from the production of goods and services, such as wages, profits, and taxes. GDI rose 4.3% in the third quarter of 2018, compared to a 1.3% increase in the third quarter of 2017. The average of gross domestic product and gross domestic income, a supplemental measure of U.S. economic activity that equally weights GDP and GDI, increased 3.8% in the third quarter, compared with an average annual increase of 1.9% in 2017. The federal deficit was roughly $779 billion for fiscal year 2018, an increase of $113 billion over the 2017 fiscal year deficit of $666 billion. The government fiscal year runs from October through September.



Inflation, as it relates to consumers, had reached the Federal Reserve’s stated target rate of 2.0%, only to fall below that level in November. The personal consumption expenditures (PCE) price index, the measure of the increase in the prices of goods and services purchased by consumers, was 1.8% higher in November 2018 compared to November 2017. Core PCE, which excludes the volatile food and energy components, expanded at an annual rate of 1.9% in 2018. Personal (pre-tax) income increased 4.1% in the third quarter of 2018 compared to an annual rate of 4.4% in 2017. After-tax income (disposable personal income) increased 4.0% in the third quarter of 2018 after expanding at an annual rate of 4.4% in 2017. Another measure of inflation, the Consumer Price Index, measures the price level of a basket of consumer goods and services purchased by individuals. Over the 12 months ended November 2018, the CPI rose 2.2% (2.1% in 2017).



A lack of inventory, coupled with rising mortgage interest rates, contributed to a rather lackluster performance in the housing sector. Through November, existing home sales are down 7.0% from a year ago. The November annual sales rate of 5.32 million was notably lower than the 5.72 million rate for November 2017. The median existing-home price for all housing types in November was $257,700, up 4.2% from November 2017 ($247,200). November’s price increase marks the 81st consecutive month of year-over-year gains. Total inventory of existing homes for sale in November was 1.74 million — 4.2% greater than last November (1.67 million).



Manufacturing and industrial production performed better in 2018 than the prior year. The Federal Reserve’s index of industrial production revealed that total industrial production rose 3.9% over the 12 months ended in November 2018. Over the same period, the output of consumer goods increased 1.5% and production of business equipment expanded 4.1%. Capacity utilization for manufacturing increased 2.0% over the past year. New orders for manufactured durable goods (expected to last at least three years) increased by 8.4% from 2017. Shipments were up 7.2%. Capital goods — tangible assets used by manufacturers to produce consumer goods — also expanded in 2018. New orders for capital goods increased by 8.5%, and shipments of capital goods expanded by 7.3%.



From January through October, the international trade deficit for goods and services was $503 billion, or 11.5% greater than the deficit over the same period in 2017. The goods deficit totaled $729 billion, while services had a surplus of $226 billion. Exports increased from $1.944 billion in 2017 to $2.093 billion. Imports increased from $2.400 billion to $2.600 billion. Import prices increased 0.7% over the past 12 months ended in November. Export prices expanded by 1.8% over the 12 months ended November 2018.



International equities did not enjoy the same upward momentum in 2018 compared to the prior year. Economic expansion stalled for many international economies as heightened trade tensions between the United States and several of its trade partners and tighter monetary policies cast a shadow over economic expansion. Following demands for more favorable trade terms, the United States imposed tariffs on imports from several of its trade partners. While negotiations ultimately resolved trade wars with some countries, notably Mexico and Canada, a major impasse still exists between the United States and China. The impact on both countries has been palpable, particularly in China, where fixed-asset investment, retail sales, and industrial output have each decreased in 2018 compared to 2017. In Europe, Great Britain is scheduled to leave the European Union soon, yet it remains unclear under what terms Brexit will take place. Also, several countries tightened their respective monetary policies in 2018 on the heels of economic growth in 2017. The lower interest rates in 2017 that helped propel consumer spending and business investment began to rise in 2018, hindering equity and economic expansion.

Eye on the Year Ahead

The economy grew at a respectable rate in 2018. Will it continue along the same path in 2019? Fears of an economic slowdown lingered at the end of last year and a slowdown may continue into 2019, although global recession is less likely. The housing market hasn’t picked up the pace and is generally lagging behind other economic mainstreams. Also, with inflation inching ahead, economic stimulus may be easing, which could lead to tighter financial conditions moving ahead. Certainly if the global trade wars between the United States and China continue, not only will the impact be felt domestically, but a rift between the world’s two largest economies is sure to affect global economies and markets as well.