“Everybody has a plan until they get punched in the mouth!”

Former heavyweight boxing champion and philosopher, Mike Tyson

 

All investors got punched in the face in 2018 with every major asset class posting losses last year. Global stocks, bonds, real estate, commodities, and even new age “assets” like cryptocurrencies all lost ground in rather dramatic fashion in the final quarter of the year. Literally the only positive returning asset was cash but of course that doesn’t trump inflation. The below chart is to mid-November (before the rather miserable 9% odd drop in December got underway) and it illustrates the percentage of asset categories that posted negative total returns.

Not since the dark days of the Financial Crisis (10 years ago this past fall) have markets experienced such risk aversion. As chaotic as 2008 was, at least investors made money in government bonds that year which was not so last year. And for almost inexplicable reasons, investor sentiment readings were actually worse last month than those that were recorded during the Financial Crisis when banks were collapsing like dominos and many families were thrown out of their houses. This just doesn’t seem reasonable to most observers so why all the negativity?

After recovering the lost ground from the long overdue spring correction, markets made new highs as we closed out September with companies reporting good revenue growth and great earnings. Then the mood darkened in early October when Federal Reserve Chairman Jerome Powell spooked the markets with an off-the-cuff comment that interest rates were a long way below “normal”. Suddenly the market feared that the Federal Reserve was going to raise interest rates more than expected and the risk of a policy error grew. After all, as the saying goes, most bull markets don’t die of old age…they are killed by rising interest rates and now the Federal Reserve seemed intent on doing just that.

Suddenly the markets viewed the glass as half empty and became fixated on the notion that things were as good as they could possibly get for this cycle and therefore the top must be in. Well unless the market gets tax cuts every year, 2018 was always going to show a spike in earnings and 2019 was going to be a return to trend but we knew that a year ago! In any event, the selling that ensued first seemed to be an attempt to lock down profits which then morphed into a rush of realizing losses to offset prior gains. After all, it is hard to explain to investors how they have capital gains taxes to pay when they lost money overall. Stories of hedge fund liquidation started making the rounds and in fact over 140 hedge funds closed their doors in December. We got into a negative feedback loop where selling begets more selling and with more and more money being managed by “trend following trading algorithms” things got a little overdone to say the least. Rational investors were left scratching their collective heads trying to justify why the market was suddenly and unrelentingly so hostile.

Clearly there were also political factors that contributed to the market angst. The increased rhetoric around the Trump trade war with China played an obvious role as it turns out that “trade wars are not easy to win” after all. Also the ongoing turnover in Trump’s White House (the surprising resignation of the Secretary of Defense in December being the most recent example), and the ongoing Mueller investigation handing down its first convictions didn’t help the mood. The newly elected Democratic Congress promised no end to Trump investigations and to top the year off as an early Christmas present, the US government went into another shutdown displaying Washington’s new dysfunction. While not the main reason for the Christmas Eve selloff (worst Christmas Eve stock market performance on record) it certainly didn’t help the cause.

The question we really need to answer is will there be a recession on the horizon for the US economy? If yes, then all of this negativity will prove correct but how can we contemplate a recession with 2.5% economic growth expected for 2019? Sure it will be down from the 3.5-4% growth that the US economy put up in 2018 but that is hardly recessionary! We can talk ourselves into a recession pretty easily (and bad investment results can certainly contribute to such) but it seems very premature to call an end to this expansion based on the economic numbers that we see. While it is unusual to have 2 full market corrections in a calendar year (first time since 1950 actually), we still see this as another correction and not the start of a full blown recession and ensuing Bear market. History also tells us that investors tend to over-emphasize the ability of the stock market to predict recessions when in actuality stock markets have had mixed results at best in doing so. Wall street and economists even have an old tongue in cheek expression that stock markets have managed to predict 9 of the last 5 recessions (forecasting twice as many than have actually come to pass). And unless there is a US recession, the markets have likely gotten it wrong this time and if that is the case, with markets being substantially cheaper today than they were a year ago, better days are ahead. If political tensions and interest rate fears continue to subdue in the early months of 2019, I expect the Grim Reaper outlook to be replaced with a Goldilocks one.