Clients and Friends,
It is my great pleasure to wish you a very Happy New Year on behalf of Mader & Shannon Wealth Management.
After experiencing the ebbs and flows of any year in the market it is very tempting to proclaim that it was ‘a year like no other.’ Unfortunately, that can come off as cliché, or worse, nearsighted. Conversely, I think we can all agree that from both a political and markets perspective, 2018 was action packed. And that action does provide plenty of fodder for discussion and reflection.
Throughout the year, we provided clients and advisors with 9 market updates. Some were crafted to offer context during a particularly volatile section of the year; others were our attempt to shed light on a theme in the market that we hoped would be of interest.
In many of these updates, we warned that 2018 was likely a ‘new phase’ of the bull market, and that it could be a volatile consolidation year. While nobody enjoys a stalled and choppy market, consolidations do tend to provide a necessary pause in a bull market advance (2015-2016 was the most recent example). The real risk is not that a consolidation arises, but that it can become a bear market if the outlooks for economic growth or monetary policy deteriorate.
The upcoming earnings season and a potential crescendo in Chinese trade negotiations over the next few weeks will quickly set the tone for 2019. But whether the market is consolidating or in the process of breaking down, we feel that we are uniquely positioned to both protect assets and look for investment opportunities.
To lay out the year that was and help shed some light on the consolidation vs. bear market debate, we’ve enlisted the support of the Chair of our Investment Strategy Committee, George Shannon. He was assisted by our Investment Strategist, Austin Harrison, and their analysis is directly below my signature.
Finally, Jim, Bret, and Taylor have asked me to remind clients that the beginning of a new year is an excellent time to evaluate your financial plan and make any necessary adjustments. To set up a review, or if you have any questions or concerns, please reach out.
The Return of Volatility: Consolidation or Bear Market?
Two years ago marked the beginning of a truly remarkable period for the market. In 2017, equities recorded one of their least volatile years on record. In nearly a century of stock market history, only 1964 had less variation in its daily returns, but 2017 returned nearly 6.5% more.
This favorable environment conditioned market participants to ‘buy-the-dip’, as declines failed to last and the second half of the year saw 38 new all-time highs. Investors cheered a synchronized global growth that was driving economic strength. The S&P 500 Index (green in the chart below) began 2018 much the same, ripping 7% higher over its first 18 trading days and tracking the performance of equities around the rest of the world (blue).
The investing environment has since changed.
By February 8, equities had experienced their first 10% decline since early 2016, and, despite climbing to set new highs in the fall, closed lower on the year. December, historically the best month of the year, was much to blame. The month had its worst performance since 1931, declining 14.8% through Christmas Eve before rallying to close “only” 9.2% lower.
The return of volatility to the markets was accompanied by plenty of destabilizing news stories. Each day there was a new headline to blame: trade wars, rising interest rates, Brexit, Mueller investigations, budget deficits, midterm elections – the list goes on. With all of that, it seems we were destined for wild markets, so we decided to see just how wild 2018 was. The answer depends upon perspective.
In 2018, the standard deviation of daily returns was 1.07%. That’s more than double the 0.42% reading in 2017, which certainly helps explain why volatility has been a hot topic in newsrooms and around dinner tables. But compared to the rest of our data set, 2018 was very, very average. The standard deviation of daily moves since 1970 is 1.06%, and marginally higher (1.17%) since 1928. Conclusion: The market was volatile last year, but no more than its historical average. We found a similar story when looking at December performance. The 15-day period ending December 24 returned -14.8%. That’s an extreme value (it’s in the worst percentile of rolling 15-day returns since our data set begins), but there have been worse periods in 5 of the last 20 years, and a 15-day period in October 2008 returned -28.4%.
Historically, other asset classes have provided a safe-haven from volatile equity markets. In this regard, 2018 truly was an outlier. In the chart below, the red bar indicates the past year’s performance, and in grey is the 15-year annual trend (2003-2018). On average, the asset class indexes below underperformed their trends by 12%.
In fact, for the first time since at least the 1980s, not a single major asset class outperformed inflation. For the investing world, 2018 may well be remembered as the year that nothing worked.
In summary, the past year has been one marked by the return of volatility and a difficult environment for investors. Whether the market is simply in a large consolidation pattern that will continue higher, or if this is the beginning of a nasty bear market, remains to be seen.
George R. Shannon
Chairman of Investment Strategy Committee
Vice President of Institutional Development