2018: The Year In Charts

These are the charts and themes that tell the story of 2018…

I. All Good Things…

…must come to an end. After 9 straight years of gains, the S&P 500 finished down 4.4% in 2018, its first down year since 2008.

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The record run from 2009-2017 thus ends in a tie with 1991-1999 for the longest positive streak in history.

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Was a down year a foregone conclusion? Far from it. At the close on September 20, the S&P 500 was sitting at an all-time high, up 11% on the year.

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Over the next 3 months, it would give back all of those gains and more, with a peak-to-trough decline of over 20%.

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Why were stocks going down? Take your pick: rising rates, China slowdown, trade war, weakness in housing, etc. There’s always a “reason” after the fact.

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Regardless, this was now the largest stock market decline since 2011, leaving the S&P 500 at one of its most extreme oversold levels ever.

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Investors who were extremely greedy at the start of the year were suddenly extremely fearful.

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On Christmas Eve, the S&P was down 14.8% on the month, on pace for the worst December in history. A post-Christmas bounce averted this ignominious feat, but the damage was done.

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At -9%, December was the largest monthly decline in the S&P 500 since February 2009.

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II. Bear Markets and Recessions

Does this mean a recession is coming? That’s the question everyone seems to be asking today.

Looking back at history, the answer is far from clear. This is now the 21st Bear Market since 1929. Of the previous 20, only 11 were associated with a recession (55% of the time).

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Sometimes a Bear is just a Bear (the stock market is not the economy). Is this one of those times? We’ll find out soon enough.

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III. When Multiples Contract

If someone told you that earnings would increase 26% in 2018 and that profit margins would hit record highs, you would probably guess that stocks would be higher.

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That would’ve been a reasonable assumption in most years, but not in 2018. For the first time since 2011, we saw multiples contract (-25%), with the P/E ratio on the S&P 500 moving from 21.4 at the start of the year to 16 at the end.

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Investors learned once again that stock prices lead earnings, not the other way around. The strong equity markets of 2017 were anticipating the strong earnings of 2018.

What is the multiple contraction this year telling us about future earnings growth? That it’s likely to slow.

How will market participants respond to such a slowdown? Nobody knows because it requires predicting investor sentiment (what multiple will investors pay for next year’s earnings?). Needless to say, predicting investor sentiment is a difficult game, which in turn makes predicting future stock prices exceedingly difficult. Further complicating matters is the fact that predicting future earnings is not any easier.

IV. No Place to Hide

In a broadly diversified portfolio, there’s usually something working in any given year. When stocks are down, bonds are typically up. When bonds are down, stocks are typically up. When stocks and bonds go down together, something else is often up (TIPS, Commodities, REITs or Gold).

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Disclaimer: At Pension Partners, we use Bonds as our defensive position in our absolute return strategies for all of the above reasons. Bonds have provided a more consistent defensive alternative to ...

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