As I do every month, it’s time to take a look back at what happened in the previous one and what it could mean going forward. We have a lot to cover.
A look back
The big picture. U.S. markets ended December down between 8 percent and 10 percent. This decline took both the quarter and the year into negative territory for the first annual loss in almost a decade. International markets did better for the month but substantially worse for the year. Even in fixed income, the best result was a breakeven for the most inclusive index, while others showed annual losses. There was nowhere to hide, and much of the damage came in December itself.
The role of politics. After several months of concerns, all the negative political trends came together as one crashing wave. The U.S. government shut down, giving markets a taste of what the 2019–2020 congressional cycle could mean for governance as the new Congress and White House went head to head. Trade continued to rattle markets, with the U.S. and China in contentious negotiations. Europe continued to teeter. Great Britain tried but failed to come up with a plan to leave the European Union, and the Italian banking system continued to weaken. Back in the U.S., the White House opened a second front against the Fed, angered by the recent rate increases. From a political perspective, pretty much everything that markets have been worrying about for the past several months happened in December—in a big way.
Economic worries. Political concerns, of course, came against a couple of months of market declines based around fear of a slowing economy, even of a recession. These declines were exacerbated in December by another Fed rate increase and a fairly hawkish press conference, which markets took to mean that more rate increases were already baked in for 2019. Just as with politics, many of the economic worries came into play all at the same time.
Looking at all of these factors, it should have been no surprise that the markets reacted so negatively. With valuations at the very high levels of midyear, a lot of good news and positive expectations were baked in. When those expectations started to crack? So did the market.
A look ahead
Signs of improvement. Confidence-led drawdowns can certainly be sharp, as we have seen. But they also tend to be short lived. With all the bad news that hit in December and the fourth quarter, there are also signs that things could get better. The Fed’s rate increases, for example, were based on a strong economy. So for the markets to worry about both rate increases and a weak economy was, at best, inconsistent. Trade worries waxed and waned depending on the news from Washington and Beijing, and they are showing signs of waning again in early January. We always understood the new Congress would struggle with the White House. So, when the shutdown is resolved (and it will be, sooner or later), there will hopefully be more clarity about what that relationship will look like. Brexit will largely be resolved (again, one way or another) in a couple of months, and the uncertainty will subside. For all of the bad news, we can reasonably expect either improvement or resolution. In some cases, that process is likely underway right now.
Solid fundamentals. We also had economic news in December that should help confidence moving forward. Hiring continues to be very strong, and wage growth is accelerating. Consumer and business confidence remain at very healthy levels. Longer-term interest rates are, in fact, back down, despite the Fed’s rate increases. Corporate earnings continue to grow. Despite the political headwinds, the economic and corporate fundamentals remain solid.
Perception versus reality
Overall, we saw a hurricane of bad news in December on top of a couple of months of market weakness, which took markets even further down. But the damage was largely political, which hit confidence but not the fundamentals. Confidence can drop quickly—but it can also recover when those worries don’t prove out.
As such, it is very possible that many of the issues that shook the markets at the end of 2018 will resolve in a way that is better than markets expect—or at least not get any worse—and allow confidence to recover. December was a bad month in many ways, but more in perception than reality. Hopefully, the perception will adjust upward in January, which is what usually happens.