Market Watch: 2018 in Review

Posted 23 Jan 2019 by Rick Irwin, CFP, CLU

Most investors will be quite happy to relegate 2018 to the history books. In fact, by some metrics, it was the worst year on record in terms of the highest percentage of asset classes (stocks, bonds, commodities, currencies) being negative.

Duetsche Bank, for example, tracks 70 different asset classes. In 2018, 93% of these were negative for the year. (The previous high was in 1920, when 84% of then-37 asset categories posted negative returns.)

The Year that wasn’t

Despite the breadth of the negative performance, the magnitude of losses was not nearly as severe as, say, 2000, or 2008. Here at home, the Canadian stock market (S&P/TSX) was weighed down by plunging energy prices as well as weakness in materials and financial services and finished the year with a loss of 8.9%. Overseas markets, both the US and Asia, saw declines in the 10-15% range in local currency terms. The US stock market (as broadly measured by the S&P 500 index) was the “least dirty shirt in the laundry” with a more modest loss of 4.4%. For Canadian investors, however, the US market offered one of 2018’s few bright lights due to the weakness of the Canadian dollar, which declined about 8% relative to the U.S. dollar for the year, providing a gain of about 4% in Canadian dollar terms for US investments. Bonds, normally a safe haven in periods of market volatility, posted losses as well. Using US Data from the St. Louis Federal Reserve, this marks only the third time in 90 years that bonds and stocks both lost money.

Wall of Worry

It started out on a bright note with a big rise in US stocks in January before fizzling in February and rebounding in the summer months, when the S&P 500 Index reached an all-time high and set a record for the longest bull market in history. Fears of the US Central Bank (“The Fed”) raising interest rates too steeply, thereby pushing the US economy into a recession, initially sparked the sell-off. Rising short-term interest rates in North America are leading to tighter financial conditions, while slower economic activity has weighed on commodity prices – particularly oil – and the materials and energy sectors.

Interest rate hikes and slowing economic growth weren’t the only factors weighing on investors’ minds. Geopolitical tensions, namely increasing trade friction between the U.S. and its trading partners, particularly China, and the Brexit negotiations between the U.K and the European Union, further elevated investors’ concerns.

Regardless of the cause, there is no doubt that market turbulence can be unsettling for investors, and last year’s volatile performance was particularly jarring following the unusually calm and steady returns in 2017. The reality, however, is that downside market volatility is normal.

The chart above shows that in most years, the S&P 500 will experience several days in which the value of the index drops by 2% or more. In this context, 2017 was an outlier with nearly non-existent volatility. Last year, with 15 days registering losses of 2% or more, the level of volatility for the index returned to a more “normal” range.

Downside Volatility is Normal

The fact is, market volatility is not always a bad thing. Professional money managers often welcome market declines as a necessary ingredient for positive returns as it creates opportunities to add to existing positions or buy higher-quality businesses at reduced prices. In 2017, asset prices remained elevated, providing few opportunities to shop for “bargains.”

Furthermore, it is nearly impossible to predict when market swings will occur. Studies have shown that investors who attempt to time the market – that is, sell before a downturn and reinvest when markets are poised to rise – often end up missing the best upside days and underperform relative to those who stay invested. Markets do not advance in a straight line, but historically the long-term direction for equities has been up.