Market Data Bank

4Q 2018


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Stocks posted a vicious -13.5% loss in the fourth quarter of 2018, following a huge +7.7% total return in the third quarter, a +3.4% return in the second quarter, and a -0.8% loss in the first quarter of 2018. It was the worst quarterly performance for stocks since 2011.


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A fundamental financial concept to remember is that whenever stocks plunge, you earn the equity risk premium.


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A rubric of modern portfolio theory taught at colleges and universities holds that investors get paid extra return for taking risk.

The risk premium is the amount you get paid for owning a risky asset.


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As the fourth quarter of 2018 began, Federal Reserve Board Chair Jerome Powell depicted a throwback to conditions seen only briefly in post-War history, and the latest data reinforced what Mr. Powell called "a remarkably positive outlook."


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The difference between the 7.2% average annual return on the S&P 500 index and the 2.1% return on a risk-free T-Bill is 5.1%.

The extra return annually averaged on equity invested in America's 500 largest publicly-held companies in the 21-year, 11-month period ended November 30th, 2018 - is the equity risk premium, 5.1%.


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In the context of the equity risk premium, the recent plunge in stock prices has been no huge surprise.

The plunge followed a spectacular bull market run - nine consecutive calendar years of positive returns and a 10.8% return through the first three quarters of 2018.


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Times of painful stock market losses are when investors actually earn the equity risk premium - and that's an important financial fundamental to remember in times like these.


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Small caps, as would be expected because they have a statistical reputation for being the riskiest types of stocks ranked by market-capitalization.

Value style stocks - stocks viewed as attractive because they're undervalued rather than growing their profits - defied conventional wisdom based on history by losing more than small growth company equity issues. But the difference was slight, and the main takeaway from this breakdown of the Standard & Poor's 500 is that blue chips lost 14% of their value, while riskier small-caps lost about 20% of their value.


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A sharp change in sentiment about the economy set off a plunge in all but one of the 10 industry sectors delineated by Standard & Poor's.


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The loss was not confined to the U.S., but U.S. stocks underperformed other major foreign stock market indexes.


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U.S. stocks represent one component of a broadly diversified portfolio.

We always try to make this really clear in these reports about performance, but it's often not appreciated during long bull markets.

Gold stocks, intermediate-term U.S. Government and municipal bonds gained in value while most other assets classed were clobbered and the S&P 500, even with dividends reinvested, lost nearly 14%.

It takes a major loss in stocks, like the one in the fourth quarter of 2018, to appreciate the statistical likelihood of success of broad diversification of long-term portfolios, based on modern financial history.

What caused it?


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On December 19th, the Fed chair announced a quarter-point hike in interest rates, and a bear market in stocks immediately ensued.

Stocks plunged 19.8%, meeting the minimum measure of a bear market but only after rounding.

The year ended amid heightened fear that the Fed would continue raising rates - in line with its previous public pronouncements for many months - despite the trade war with China, global economic slowdown, and federal government shutdown.


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On January 4th, in Atlanta, Jerome Powell, the chairman of the Federal Reserve, all but admitted making a mistake by raising rates on December 19th.

Mr. Powell shared the stage with his two immediate predecessors, Janet Yellen and Ben Bernanke, but Mr. Powell was the center of attention.

Neil Irwin, an economics writer at The New York Times introduced Mr. Powell and almost immediately asked the nation's most important financial officer if he had erred in raising rates.

Mr. Powell's answers were an extraordinary display of transparency at a pivotal moment for financial markets and the economy.


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Markets are expressing concerns about global growth and a trade war, Mr. Powell said, "I'll just say that we're listening carefully."

The chairman repeated that the Fed is listening to the markets several times and then, doubling down on transparency, the Fed chair said he would be taking the market's downside risks into account in making policy decisions moving forward.


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The nation's most powerful financial officer could not have made clearer that the Fed was making an important shift in monetary policy, and he did it live on the Web before an audience of several thousand viewers as well as the people in the room.

It was a poignant moment in financial history because it showed the transparency of the Fed - a uniquely American strength.

This was a moment that is likely to be remembered in financial history.


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Flanked by his predecessors, the Fed Reserve reassured financial markets it was listening to investors in the plainest of terms.

It happened January 4th, 2019, live on the web, a uniquely American act of transparency on January 4th that is likely to be recalled in financial history.


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The S&P 500 hit a record all-time high on September 20th, 2018, whereupon it dove to a Christmas Eve low, down -19.8%, in response to the Fed's reaffirming its plan to raise the fed funds target rate to 3% in 2019.

Investors sold stocks in alarm on this news because hiking the short-term rate to 3% would probably result in an inverted yield curve, which has been the key precursor to every recession in the post-WWII era.


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2018 was a bad year all around. China, a high-risk market, plunged -18.6%, and was the worst hit among major global bourses. Europe, emerging markets, and Asia were all double-digit losers. It was a bad calendar year by long-term historical standards.


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Hardest hit among this broad group of 13 asset classes in calendar year 2018 was oil, losing 20.5% in value. Threat of a global slowdown caused a drop in oil and other commodities on expectations that demand for raw materials would soften. The fear of a global slowdown caused a decline in 11 of the 13 asset classes shown. Even gold, which sometimes shines in troubled times, lost 2.8% in 2018. Muni bonds and intermediate-term U.S. Treasuries returned about 1% for the year.


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Though the S&P 500 lost 4.4% in calendar year 2018, health care stocks gained 6.5%. It was the best performing of 10 industry sectors benchmarked by the S&P 500, an index measuring return, risk, and characteristics of America's largest 500 publicly-held companies.

Health care returned 10 percentage points over the 4.4% loss on the stock share of the S&P 500.

It begs the question: Was it predictable?

Everyone knows health care costs are rising, so wasn't it obvious that in December 2017, health care stocks would outperform?


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The answer is "No," Predicting the best equities or winning sectors is a losing game, according to research we license from economist Fritz Meyer, an independent economist.

The sector forecasts of 10 "top" Wall Street retail strategists selected by Barron's, a fabled financial weekly, are published in a cover story on December 11th, 2017.

Two of the strategists picked health care to lead in 2018 and two said health care stocks would lag the S&P 500 - zeroing out the consensus forecast of the 10 strategists, according to Meyer's data.


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This chart shows the performance of the consensus forecast of strategists surveyed in Barron's annually since 2007.

If the Wall Street strategists predicted which sectors to buy or sell accurately every year, the black dots would all fall along the red line, but instead they're all over the chart! Scattered randomly!


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After trading sideways in 2015 and most of 2016 - and suffering two frightening descents - the stock market surged after the November 2016 election, reaching an all-time peak on September 20th, 2018.

Stocks dropped -20%, and plunged worst on Christmas Eve, on fears that the Federal Reserve was carrying out its plan in the face of a trade war with China, global economic slowdown and a government shutdown to raise its lending rate to 3% by the end of 2019.

The Fed's action raised fears that it was making a mistake and on course to invert yield curve. Fed mistakes like this in the past preceded every recession in the post-War U.S. history.

Over the last five years, including dividends, the S&P 500 total return index has gained +50%, compared with a gain of +36% in the S&P 500 price index, with the 14% difference attributable to dividend reinvestment. The five-year gain of +50%, or approximately +10% per year, is right in line with the stock market's long-term annual total return going back 200 years as described by Wharton professor Jeremy Siegel in his seminal book, Stocks for the Long Run, first published in 1994.


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Growth stocks dominated in the five years ended December 31st, 2018. Less volatile companies priced not for growth but for their intrinsic value trailed. In economic expansions, investors logically pay up for growth. However, the extent to which growth dominated and the nature of its advance are unpredictable.

This is where many investors become susceptible to predictions about performance, returns and risk.

Broad trends in the economy are predictable and are ultimately what matters most to young investors and retirees. Making predictions about which sector investors will prefer in the next year is unwise.


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For the five years ending December 31st, 2018 the lagging sectors - energy, communications services, materials, industrials and consumer staples - consist mainly of stocks that are classified on the value side of the ledger, and where earnings growth has lagged the growth sectors of the economy.

The technology sector, led by huge gains in Apple, Microsoft, Facebook and Google, was the leader among the 10 sectors in the S&P 500.

The energy and material sectors were slammed by a collapse in the price of crude oil and most other commodities. The price of oil, while up dramatically from its early 2016 bottom of $26 per barrel, is still well below its peak 2014 price of $114 per barrel. The energy sector of the stock market is highly correlated with crude oil prices.


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For the five years ended December 31st, 2018 what particularly stands out is how the U.S. outperformed the world's other major equity benchmarks by a substantial margin.


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For the five years ended December 31st, 2018 what particularly stands out is how U.S. stocks have outperformed every other asset class.


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INDEX OF QUARTERLY MARKET SUMMARY