For risky assets, December was the most difficult month in a year that proved to be particularly tough sledding for stocks. During times of market turbulence, it's particularly important to look through the volatility, use a diversified approach, and stay invested in order to achieve your long-term financial goals.
Tidings of comfort and joy had to be found in places other than the financial markets in December. Fears of a U.S. recession and an extended government shut-down were added to the list of concerns that include trade tensions, profit margin pressures, Federal Reserve policy mistakes, and global economic weakness.
Month-over-month returns were deep in the red for a broad range of risky assets. U.S. small company stocks fared the worst, falling nearly 12% during the December. US large company stocks fell 9%. Relatively speaking, international stocks fared somewhat better, with developed market equities declining by 5.4% and emerging market stocks falling by 2.7%. Alternative asset classes also struggled, as commodities declined by nearly 7% and Real Estate Investment Trusts dropped by more than 8%.
Bonds provided refuge from the stock-market volatility in December. Longer-term Treasuries performed most strongly, rising more than 5.5%. Intermediate maturity Treasuries and higher quality corporate bond indices rose between 1-2%. High yield bonds, which are more closely linked to equities, fell by 2.2%.
A December That Wasn’t So Merry
Why weren’t the markets more cheerful? Political and economic uncertainty increased, investor sentiment soured, and selling followed. It seemed that each new development weighed progressively heavier on stocks in December.
Political dramas played out on a few stages. While Presidents Trump and Xi agreed to a trade truce in early December and more negotiations in January, the markets were skeptical that a US / China trade resolution would emerge quickly. And a new political situations unfolded during the month, including: a partial government shutdown over border security funding, the departure of the Defense Secretary over military policy disagreements with the President, and a failed attempt by the Treasury Secretary to verbally sooth volatile markets.
Beyond politics, concerns mounted in December over a possible recession in the US coming sooner rather than later. A flattening Treasury yield curve, which has preceded economic downturns in the past, grabbed attention. Also, the Federal Reserve’s decision to raise short-term interest rates, while broadly telegraphed, wasn’t warmly received. Fed Chair Powell’s press conference that followed the rate decision also failed to sooth volatile markets.
Some Cause for Optimism
If inflation remains contained, the Fed is likely approaching the end of its interest rate-hiking cycle, which has pressured equities lately. Fed funds futures, which investors use to bet on the direction of Fed policy, currently show a 90% probability that short-term rates will end 2019 at or below current levels.
Also, with economic growth likely to slow in the U.S. and decelerate further in China, the incentive is high for both countries to get a trade deal done. Greater certainty regarding interest rates and trade, and less political drama, are all factors that could help reduce stock market volatility in 2019.
The December equity drawdown was sharp and painful. However, we believe it is critical to look through trade conflicts, political dramas and day-to-day market volatility. At Laurentide, we recommend staying invested, using a diversified approach, and sticking to your investment plan – all important elements that will help you meet your long-term financial goals.
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Rob Kania is a Principal and Co-Founder of Laurentide Advisory