A Wild Month for Wall Street

The Dow Jones Industrial Average delivered a historic day of performance on the day after Christmas. The index snapped back from a dismal day of trading on Christmas Eve and realized a gain of over 1,000 points. Other major US indexes swelled to similar levels in terms of percentages. The S&P 500 and NASDAQ, both executed daily returns in excess of 5%.

US stock prices sunk in what was a myriad fourth-quarter and especially dour December. From October’s peak to December’s bottom, the S&P 500’s index level had fallen almost 15%. Small-cap stocks have given back even more since their last peak in August. Market conventional standards would characterize US large-caps near correction levels and US small-caps in bearish territory.

Last month was the second worst December on record for the S&P 500. The worst recorded December in history occurred in 1931. In 1931, the US economy was in the midst of a depression. Since today’s economy looks nothing like a depression, last month’s comparison to 1931 is likely only hyperbole. However, the example highlights how outlying tail-events can and do occur in the equity markets from time to time.

Foreign stocks own a similar track record in 2018. Their downward descent only began earlier last year, in January to be exact. Developed and emerging markets closed last year with double-digit losses. On a positive, emerging markets crawled back out of a bear market before last year concluded, but are still quite depressed. The big performance divide that separated stocks in the US from foreign stocks is now closely narrower from where it was during much of 2018.

An anticipated slowdown in macro-economic activity is providing the narrative for the recent collapse in equity prices. Market and policy watchers alike have already witnessed China’s growth dip and the jury is still out on whether other big economies like Germany or Japan are in a recession. Meanwhile, the US grew on fiscal stimulus while the rest of the world began to cool. Now that sufficient time has elapsed for the US tax-stimulus to deliver, markets are left wondering, what’s the next driver for asset prices?

“US stock prices sunk in what was a myriad fourth-quarter and especially dour December. From October’s peak to December’s bottom, the S&P 500’s index level had fallen almost 15%.”

The policymaking committee of the Federal Reserves appears less willing to give markets another hand out. The monetary authorities put through another interest rate increase in December and described the liquidation process of their balance sheet as being on “auto-pilot.” Their balance sheet is set to withdraw prior stimulus of about $50 billion per month or $600 billion per year, which some say, is indirectly equivalent to additional rate increases on top of what’s already been done.

In regards to a slowdown, the devil is in the details. Unfortunately, the details probably won’t become available for another nine to twelve months, after enough time has passed to see the corporate earnings of publicly traded firms. Investors argue that today’s price levels for future earnings are quite cheap. That supposes that next year’s earnings will deliver as expected. In fact, today’s equity markets could be signaling that uncertainty about future earnings is much higher than ever before.

A lot of optimism was washed out of the US stock market in the last quarter of 2018. That could provide an opportunity for investors who are willing to step in as liquidity buyers for sellers that are fearful about owning stocks. For tried-and-true investors, the end of 2018 amounts to only a noisy market. They realize that market volatility and drawdowns are part of the costs associated with being invested in equities. Of greater relevance, is the belief that equity investments will continue to deliver excess-average returns over bonds given a sufficiently long enough investment horizon.

Advisory Alpha