December was a bad month

December was a bad month for the financial markets.  Simmering worries about the global economy and central banks raising rates came to a head.  There are many catalysts to blame – worries about Brexit, with still no solution in sight as the March 29th deadline looms closer.  Official data on Chinese trade data, and overall economic activity, continue to paint a bleak picture.  The housing market in the U.S. continues to decelerate.  The Fed has, so far, not changed course.  All of this added up to a lot of selling in the month of December.  

   

Stocks & Bonds

The U.S. stock market ended the year in negative territory, and international stocks fared even worse.  Bonds fared slightly better.  Inflation continues to be more of an idea than a reality – which theoretically gives the Fed some room for stimulus if financial markets continue to sell off.  Here is 2018 by the numbers:


Commodities & Currencies

Oil prices fell 10.76% in December as a ‘risk-off’ attitude dominated most major markets.  After starting the year at $64.31 per barrel, oil closed out the year at $45.72, a drop of nearly 25%.  Although the dollar weakened just over 1% in December, for the year it ended up 4.40%.  The Fed’s actions to raise interest rates, as well as the dollar’s traditional ‘safe haven’ status, both likely contributed to the rise.    Gold jumped 5% in December, as the yellow metal usually performs well when stocks sell off severely.  However, it’s appeal as a safe-haven was tempered by rising interest rates, which make it more expensive to hold the metal and wait patiently for price appreciation.  Despite the December bump, gold was down 1.91% for the year.

Economy

The ISM Manufacturing PMI in December was 54.1%, down sharply from the November reading of 59.3.  The non-manufacturing, or services, index came in at 57.6%, also down from the month before.  Both numbers continue to show expansion, but at a slowing rate.  Due to the partial government shutdown, the Commerce Department has not released any new data on GDP.  The last information we have shows that the economy grew at an annual rate of 3.4% in the 3rd quarter.  We should have information on the 4th quarter, and a better idea of full-year growth, if/when the government re-opens.        

The National Association of Realtors reports that existing-home sales in December fell by 6.4% from the rate in August, and are 10.3% lower than they were a year ago.  The median home price rose 2.9% to $253,600 from a year ago.  Median home prices have been rising for the past 82 months.  The average 30-year mortgage rate in December was 4.64%, hovering near a 7-year high.  Distressed sales (foreclosures and short-sales) were 2% of total sales in December.

Commentary

The December stock market sell-off was certainly a shock, but I do not think it was really a surprise.  Most reasonable long-term investors have a sense that the economy ebbs and flows over long periods, and that we are likely more in ‘ebb’ territory than we are in ‘flow’ territory.  The directional shift always comes after excesses have built up somewhere.  In 2007, there was too much mortgage debt.  The graph below shows how mortgage debt nearly doubled in a few years leading up to 2008 – the shaded area indicates a recession.

Some believe that the new ‘bubble’ is corporate debt.  As the Fed kept interest rates exceptionally low after the crisis of 2008, corporations binged on easy money, as seen below.

Although the economic expansion has continued since 2009, the stock market is now starting to worry: what happens next?  The easy money that has juiced corporate profits for the last few years has run into two brick walls.  The first brick wall is the federal government – there are only so many trillions of dollars to borrow in the world, and Trump’s massive new deficits are now gobbling up much of the money that used to be available to the private sector.  The second brick wall is the Federal Reserve – they have not only raised their reference rates, they are also actively withdrawing funds from the financial markets.  

Against this backdrop of rising rates and too much leverage in the system, the stock market easily sells off.  Even though tariffs on China, or Brexit, are not likely to have a significant impact on the world economy, they provide enough of spark to ignite the ample dry kindling.  In December, a few sparks took hold, and the result was a decline of almost 10% in the S&P 500 in one month.

And as always, please feel free to forward this to friends and family.

Sincerely,
Greg

Data Sources:

www.standardandpoors.com – S&P 500 information

www.msci.com – MSCI EAFE information

www.barcap.com – Barclays Aggregate Bond information

www.bloomberg.com – U.S. Dollar & commodities performance

www.realtor.org – Housing market data

www.bea.gov – GDP numbers

www.bls.gov – CPI and unemployment numbers

www.commerce.gov – Consumer spending data

www.napm.org – PMI numbers

www.bigcharts.com – NYMEX crude prices, gold and other commodities



This material was prepared by Greg Naylor, and all views within are expressly his. This information should not be construed as investment, tax or legal advice and may not be relied upon for the purpose of avoiding any Federal tax liability. This is not a solicitation or recommendation to purchase or sell any investment or insurance product or service, and should not be relied upon as such. The S&P500, MSCI EAFE and Barclays Aggregate Bond Index are indexes. It is not possible to invest directly in an index. The information is based on sources believed to be reliable, but its accuracy is not guaranteed. Investing involves risks and investors may incur a profit or a loss. Past performance is not an indication of future results. There is no guarantee that a diversified portfolio will outperform a non-diversified portfolio in any given market environment. No investment strategy can guarantee a profit or protect against loss in periods of declining values. Listed entities are not affiliated.