ARQ Wealth Advisors Q4 2018 Commentary: Year in Review

ARQ Wealth Advisors Q4 2018 Commentary: Year in Review

The year 2018 was a year that nothing worked. Almost every type of investment delivered returns in the red. More specifically, 90 percent of asset classes were negative last year, the highest percentage since 1901. Counter to 2017’s phenomenal performance, 2018 delivered some of the worst returns since 2008, during the Great Recession. In fact, the month of December was the worst since 1931, during the Great Depression. Although referencing steep past recessions makes for interesting fodder, we do not believe this past year’s market performance should be lumped in with these renowned downturns. The differences between 2017 and 2018 are quite striking – 2017 was one of the lowest volatility years in history with a peak to trough intra-year loss of only -2.8 percent, while 2018 saw an intra-year loss of -19.8 percent, almost kissing the technical definition of what constitutes a bear market. In 2017, there were only four trading days with losses of 1 percent or more and five days with gains of 1 percent or better. In 2018, there were 32 down days of 1 percent or more and 37 days with gains of 1 percent or better.

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Here were the culprits for last year’s capital markets performance: 

  1. A more “hawkish” Fed: The market likes to test new Federal Reserve presidents, and Jerome Powell was definitely put to the test. With a path to interest rate normalization, the four rate increases in 2018 coupled with Powell’s aggressive commentary spooked the equity markets and drove rates higher and bond prices lower.
  1. Trump’s trade war: The administration has kept its promise to put pressure on many countries for more favorable trade deals. This has created significant fear and uncertainty about the effects on U.S. corporations that export along with other aggressive responses from China and Russia specifically.
  1. Peak earnings: U.S. corporations delivered incredible corporate earnings growth in 2018 of more than 20 percent, the highest in eight years. Despite this metric, fear that earnings growth has peaked and will come back down to earth overshadowed the above-average results.
  1. Strong U.S. dollar: Based on rising rates and strong economic data, the dollar gained 4.4 percent against other major currencies, putting pressure on foreign markets.

Economically, the U.S. appears to be on solid footing. GDP growth for calendar year 2018 will end up in the 3 percent range when the final numbers are turned in. Unemployment is near historical lows and the manufacturing sector has grown for 28 consecutive months. Possible cracks in the economy include housing and autos. That said, consensus GDP forecasts are in the 2 percent range for 2019, indicating some slowing in the overall economy. The Fed needs to take this into consideration as they consider future additional interest rate hikes. Being that a recession is defined as two consecutive quarters of negative GDP, there is still more runway for economic growth and strong market returns in this cycle.

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Equity Markets Overview

Stocks delivered their worst returns in a decade last year. Unfortunately, the occasional negative return in equities is the cost of admission for investing in the stock market. These downturns can happen quickly, without notice, and for reasons that sometimes feel counterintuitive. It is also important to understand that just as quickly as markets can plunge, they can recover. Therefore, timing short-term trends is impossible. From an asset allocation standpoint, ARQ Wealth overweights/underweights specific asset classes based on valuations and/or pervasive economic trends. For example, if certain sectors in the market are trading at high valuations, we will trim exposure. On the other hand, if certain sectors or asset classes are a bargain, we would look at this as a buying opportunity. Bottom line: One of the best predictors of future returns is valuation.

Equities across the board are simply cheap at current levels. Not only are U.S. stocks a bargain, but foreign stocks are even more attractive.

The recent market downturn combined with 2018’s outsized corporate earnings growth, low inflation and low interest rates make for a promising backdrop for equity returns over the short-term. The intermediate-term outlook is dependent on the Fed’s monetary policy, the ability of the administration to come to an agreement with China, and inflationary pressures. Over the long-term, stock returns (S&P 500) are almost 90 percent correlated to P/E ratios. At a current forward P/E ratio of 14.4, the next decade should deliver returns in the 9 percent range on average. This return would be consistent with the historical average return of the U.S. stock market.

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One of the major themes in the market has been the outperformance of a narrow group of growth stocks in the technology space, namely Facebook, Apple, Amazon, Netflix and Google (known as FAANG). No doubt these are well-managed, innovative companies that have huge earnings potential and market share. They also account for much of the recent outperformance of the S&P 500 versus other asset classes over the past five years. Although we have exposure to all of these companies in our strategies, we have not and will not overexpose our clients to potential price bubbles similar to what happened in the “tech bubble” in 2000-2002, when the NASDAQ dropped more than 74 percent in 2.5 years! Instead, we take a more prudent approach, diversifying across various sectors, not making large bets on a handful of companies.

Have a question? Contact ARQ Wealth to see how we can help.

Bond Market Overview

Generally speaking, fixed income markets turned in flat returns in 2018. Ideally, when stocks are experiencing volatility and delivering negative returns, bonds serve as a hedge and deliver positive performance. In 2018, one of the main reasons that stocks were negative was the rapid rise in interest rates during the first three quarters of the year, which forced bond prices down as well. It wasn’t until the fourth quarter that bond yields retreated, pushing prices back up.

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For the year, our bond and low risk non-traditional holdings delivered returns of about 0.50 percent, outperforming the U.S. Aggregate Bond Index, with less interest rate risk and less volatility. It is our contention that rates will remain under pressure as mixed economic data is disseminated. We remain defensive with interest rate sensitivity and feel that we can deliver positive returns in an environment where fixed income investing is under stress.

Now, 2019 promises to be another volatile year with political news and rhetoric getting pumped out daily, causing investor emotions to run high. Try to tune out the noise. At the end of the day, markets may react to short term news, but they always correlate back to fundamentals. Fundamentally, equity prices are undervalued. Fundamentally, our economy is in good shape. Fundamentally, corporations are flush with cash and turning out profits.

We wish you a happy, healthy and prosperous 2019.

 

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