2019 Global Asset Allocation

2018 – Year in Review

The financial markets last year were a mirror image of their performance in 2017. Two years ago, optimism reigned, as both economic and political forces seemed positive. In 2017, all the world’s stock markets rose, led by emerging markets, which were up 37%, while US markets rose 22% amidst historically low volatility. The reverse was true in 2018, when cash had the best returns and very few asset classes had positive returns. The S&P 500’s streak of consecutive years of positive returns dating back to 2008 came to an end in 2018. After three strong quarters, the fourth reversed, sharply falling 13.5%, resulting in a decline of 4.4% for the full year. Volatility, unusually quiet in 2017, returned early in 2018 and continues today. International equities, after leading the way in 2017, were much worse than the US in 2018; down 14% for the year.
The market worried about slowing earnings growth, trade wars, Federal Reserve policies, rising interest rates, possible yield curve inversion, falling oil prices, and early talk of a US recession. On the positive side, economic news was generally positive, the US economy grew at 3%, unemployment fell below 4%, and corporate earnings increased 20% year over year – helped by tax reform. After falling almost 20% from their peak, the price to earnings ratio of the S&P 500 index fell from 18.4x at the start of the year to only 14.7x at year end.

Intermediate US bonds returned 0.9% while interest rates finished the year at higher levels. The largest increase in interest rates occurred at the short-end of the yield curve, where yields gradually rose 1% in 2018. Longer maturity 10-year Treasuries started the year at 2.4%, moved to 3.2% in October, before finishing the year at 2.7%. High-yield bonds fell -2.3% as investors became less comfortable holding risker debt instruments.

Recently, the yield curve inverted with 2-year to 5-year maturities yielding less than 1-year maturities. An “official” yield curve inversion is when the 10-year yield falls below the 2-year yield, which did not happen in 2018. Inversions generally occurs when concerns arise around future economic growth and the market begins pricing in expectations for Fed rate cuts in the future. However, we caution that while the yield curve does reliably invert ahead of recessions, not every inversion is followed by a recession.