In 2018, the nearly 10-year bull market finally came to an end. For the first time since 2008, we experienced a bear market, or a 20% decline off the S&P 500’s all-time market high on September 20, 2018.
It was a strange investment year. This is the first time since 1948 that the S&P 500 index rose in the first three quarters and then finished the year in the red. During the first three quarters of 2018, large US companies earned profits of about 25% over the prior year, due mostly to President Trump’s corporate income tax cut (from 35% to 21%). However, the year ended poorly across the board. Christmas Eve marked the worst decline in the history of the Dow Jones Industrial Average. The S&P 500 index registered the worst December performance since 1931. In very narrow investment pools, the declines were even steeper. Cryptocurrency Bitcoins, which are an entirely-made-up currency, and not backed by any government or pool of assets, dropped in value from a high of $20,000 per “coin” down to $3,800.
Many have commented that last year was extremely volatile. The stock market swung from positive to negative territory by hundreds of points in a matter of hours. Much of the recent volatility is due to automated trading which is triggered by algorithms, or preset parameters, which dictate when a computer is to buy or sell equity positions. One automated trade can cause a sector of the market to cross a threshold, which prompts another automated trade that can set off a domino effect. The speed and magnitude of the machine-driven trading is often amplified, as much of the algorithmic trading is programmed to sell more as prices drop. According to JP Morgan Chase, 85% of today’s trading volume is driven by computers or auto-trading. In other words, volatility is here to stay. Automated trading became commonplace in the market around 2013. 2018’s bear market was the first time the algorithms were tested in a declining market.
A further breakdown of the investment market shows that just about every asset sector dropped in 2018. The S&P 500 index of large company stocks lost 13.97% during the year’s fourth quarter and finished down 6.24% in 2018. The Russell Midcap index finished the 2018 calendar year down 9.06%, and the Wilshire U.S. Small-Cap index was hit hardest, losing 19.67% in the fourth quarter, ending the year with a negative 10.84% return. The darlings of the US market, tech stocks, had a hard year, especially FAANG stocks: Facebook, Apple, Amazon, Netflix and Alphabet’s Google. The technology-heavy Nasdaq Composite Index dropped 17.54% in the final three months of the year, to finish down 3.88% for the year.
The international investment scene was even poorer. The broad-based EAFE index (Europe, Australasia and Far East) of companies in developed foreign economies lost 12.86% in the fourth quarter, and ended the year down 16.14% in US dollars. EAFE EM or Emerging Market stocks of less developed countries, lost 7.85% in US dollars in the fourth quarter, and lost 16.64% for the year.
Real estate equities were down also. The Wilshire US REIT index posted a 6.93% loss during the fourth quarter, finishing the year down 4.84%.
In 2018, interest rates rose 0.25% every quarter, bringing the 10-year Treasury bonds returns to 2.68%. In a rising interest rate environment, bonds tend to lose value, and they did so last year. Many prudent investors integrate a portion of both bonds and stocks inside their investment portfolio as bonds and stocks tend to perform conversely, giving you downside protection. However, 2018 created the unusual situation of concurrent losses in bond and stock investments in the same year.
In summary, all 15 investment asset classes, except for cash, posted losses for the 2018 year. Circumstantially, the current 20% market declines pales in comparison with the 86% drop in the 1930s, or the 57% drop from 2007 to early 2009. However, it is still never pleasant to see your net worth shrink over a year.
Many investment professionals had been expecting a bear market much sooner than this. On average, the market cycles every 3.5 years, meaning the market reaches a peak, contracts down to a trough, and then expands upward to a new market peak every 3 to 4 years. Due to the Great Recession in 2008, it took 4 years for the market to make up losses. From 2012 through 2017, the US economy had an expanded growth period, which often follows a large market decline like the Great Recession. Thus, 2018 was perhaps, the beginning of a “normal” market cycle.
The good news is the stock market loves predictability and “normal”. There have been 32 normal market cycles since 1900. The bad news is there is no indication that we are at the end of the current down cycle. With the government shutdown, numerous trade wars, a quickly growing federal budget deficit, political uncertainty and headlines of historical market declines, investors are understandably nervous about the near-term future. Longer-term, a recession may be the biggest concern. Most economists are reluctant to predict an economic downturn when corporate profits and economic figures have been so strong. Yet, there have been indications of softening and overall negative consumer sentiment in the market.
No one can predict whether the markets will recover in 2019 or experience a steeper decline. What we do know is that all bear markets in history have been temporary. Investors who rebalance their portfolios on a regular basis–that is, realigning the weightings inside your portfolio to a preset target to provide long-term portfolio stability–tend to do better than investors who don’t rebalance, and especially better than the investors who lose their nerve and sell in a panic during the downturn.
By all measures, the U.S. economy is still strong, albeit slowing. Therefore, cashing out while the market is down due to a normal market cycle is not a sound long-term investment strategy. Most stock market gains and losses are concentrated into just a few trading days. Statistics show that a market-timer sitting in cash, waiting for the “right time” to buy back into the market will have a 45% lower return if they miss just the best 5 trading days during a 20-year investment window, compared to an investor who adheres to a disciplined investment approach. In other words, a sounder and safer investment strategy would be to hang on tight when the roller coaster reaches a peak and takes us down a steep slope for a bit. If you feel your portfolio needs review, reach out to your financial advisor for a second opinion. A sound financial plan and a long-term view of goals and objectives can be the best offset for short-term market turbulence.