A decade of consecutive positive annual returns from the S&P 500 ended in 2018. In the final three months of the year the S&P 500 registered its worst quarterly performance in seven years and ended 2018 with a negative annual total return for the first time since 2008.

Contrary to most of the headlines you have read during the last three months, the sharp declines in stocks were not driven directly by trade wars or ongoing political dramas, all of which were with us for the majority of 2018. Instead, the break down in stocks was driven by a combination of classic economic and market concerns: underwhelming corporate earnings guidance, sudden lackluster economic growth, and disappointment towards Federal Reserve monetary policy.

Stocks initially dropped in early October as the third-quarter corporate earnings season disappointed markets. While many companies beat consensus estimates, profit warnings from select multinational and industrial firms highlighted growing concerns from analysts about peak earnings growth for U.S. corporations. That rising concern was reflected by the market’s performance during the heart of the third-quarter reporting season, as the S&P 500 declined 6.84% in October.

November saw stocks bounce back slightly from the October losses. In December, earnings concerns resurfaced and were compounded by disappointing economic readings. In early December, multiple economic indicators including manufacturing surveys and the November jobs report missed Wall Street consensus estimates, which added the potential of slowing economic growth to the list of headwinds on stocks.

The December rate hike by the Federal Reserve added yet another source of concern for investors. Specifically, the Fed increased interest rates for the fourth time in 2018, and signaled it expects to increase rates two more times in 2019. That policy decision, which was more restrictive than investors were hoping for, caused stocks to plunge as the major equity indexes dropped to fresh 52-week lows during the final two weeks of December. Markets did bounce modestly during the final days of 2018 and finished better than the worst levels of the year, but remained solidly negative on an annual basis.

Despite the legitimate concerns about economic growth, earnings and Fed policy, the news in the fourth quarter was not all bad.

First, the U.S. and China agreed to a temporary trade war “truce” and began an intense, 90-day negotiation period aimed at ending the trade war.

Second, the European Union and the Italian government reached a compromise on Italy’s proposed 2019 budget that satisfied European Commission rules, thereby avoiding a political showdown.

Lastly, most major indicators of U.S. economic growth, while exhibiting a loss of momentum, remained in solidly positive territory, meaning the economy is still growing (albeit, potentially at a slower pace). The November Employment Situation Report showed positive jobs growth and an unemployment rate under 4% while regional manufacturing surveys remained in positive territory.

In summary, 2018 was a very difficult year in the markets and for investors. Not only did most major stock indices post a negative full-year total return for the first time since 2008, but the declines came with two episodes of intense, confidence-shaking volatility in February and December.

It is important to remember that while volatile markets can and will occur, just like they did most recently in 2011 and 2015, the fundamental drivers of the multi-year rise in stocks remain generally in place, and that is critical context to remember as we begin a new quarter and calendar year.

What now?

1st Quarter and 2019 Market Outlook

Investors begin 2019 “staggered” from the worst quarter in years and with markets facing multiple headwinds. These headwinds include an uncertain outlook for corporate earnings, potentially slowing economic growth, and a lack of clarity on Fed policy. At the same time, these concerns have been acknowledged by the markets as the major U.S. stock indices begin 2019 more than 10% off their 2018 highs, and expectations for earnings and economic growth have been reduced.

At a minimum, we can expect continued volatility in stock, bond and commodity markets in the coming months. Whether the markets continue the fourth-quarter declines or rebound will depend largely on the resolution of three uncertainties facing markets: Earnings, economic growth and Fed policy.

Regarding earnings, the bulk of the fourth-quarter 2018 earnings results will be released this month. Within the next few weeks we should learn whether U.S. corporate results have stabilized, or whether the disappointing guidance we saw from companies in the third quarter continues.

Economically, investors will be focused on widely followed economic reports (including the December Employment Situation Report, ISM Manufacturing PMI, Retail Sales, Core PCE Price Index) to determine whether U.S. economic growth has indeed peaked.

The next Fed meeting occurs at the end of January and there is an important change in Fed procedure to consider in 2019. Fed Chair Jerome Powell will hold a press conference after each meeting, a change that was announced well before the recent market volatility. This additional, regular communication should afford the chairman the opportunity to communicate more effectively with investors and potentially resolve uncertainty regarding Fed policy going forward.

Finally, we begin 2019 with numerous geopolitical situations to watch. First, the U.S.-China trade talks are ongoing and there remains hope that the two sides will reach an agreement to reduce existing tariffs before the 90-day negotiation period expires. In Europe, Brexit remains unsettled, although negotiations among Britain’s largest political parties continues in an effort to approve the Brexit agreement with Europe.

Bottom line, this is an environment that requires vigilance and heightened focus on financial market moves, economic news and political developments.

While we can expect volatility to continue, especially early in 2019, it’s important to remember that the last two episodes of similar volatility (2011 and 2015) proved to be long-term buying opportunities.

Past performance is not indicative of future results, but history has shown that a long-term approach combined with a well-designed and well-executed investment strategy can overcome periods of heightened volatility, market corrections, and even bear markets.

We understand the risks facing both the markets and the economy, and we are committed to helping you effectively navigate this challenging investment environment. Successful investing is a marathon, not a sprint, and even intense volatility like we experienced in the fourth quarter is unlikely to alter a diversified approach set up to meet your long-term investment goals.

It is important for you to remain patient, and have an investment plan. We understand that volatile markets are both unnerving and stressful, they are also opportunities. We look forward to continuing to work with you on your personal asset allocation, based on your needs, downside tolerance, and timeline.

We thank you for your ongoing confidence and trust. Rest assured that our entire team will remain dedicated to helping you successfully navigate this difficult market environment.

Please do not hesitate to contact us with any questions, comments, or to schedule a portfolio review.

The information described herein is taken from sources which we believe to be reliable, but the accuracy and completeness of such information is not guaranteed by us. Past performance is not indicative of future results. The concepts discussed throughout may not consider the effect of fees, expenses, or other costs that will effect investing outcomes. Opinions expressed are subject to change without notice, and should be given only such weight as opinions warrant. The concepts illustrated throughout this document may have tax, legal, and accounting implications. The content herein is not to be construed as legal, accounting, or tax advice, and is provided as general information to assist in understanding the issues discussed. Neither Janney Montgomery Scott LLC, nor its Financial Advisors, give tax, legal, or accounting advice. Please consult with the appropriate professional for advice concerning your particular circumstances.

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