Investment Insights: 2018 In Perspective
By Cliff Aque, CFA, Investment Strategist
A popular search engine announced that “good” was the word people most searched for in 2018, but it is doubtful that it was attached to any searches related to the U.S. stock market, which posted its first negative year since 2008 (on a total return basis). Nobody would disagree that the stock market being down is not a “good” thing, but it is important to keep last year’s performance in perspective, as most other asset classes were down as well. Even core U.S. fixed income spent most of 2018 in the red, but ended the year up 0.01%. With the exception of short-duration fixed income, there was truly nowhere to hide last year.
2018 likely felt worse because the negative performance across asset classes came after two consecutive years where all 15 asset classes (Fig. 1, above) ended in positive territory. Over the past 20 years, a majority of asset classes rising together is not rare, but all of them declining is. Even in 2008 and 2015, at least one-third of the asset classes provided positive performance (See Fig. 2, below).
Amplifying the negative feelings around 2018’s performance was the return of market volatility, which we discussed on several occasions throughout 2018. Looking at the CBOE Volatility Index (VIX) (Figure 3, below), which measures future volatility expectations of the S&P 500, we see that in 2017, volatility levels were historically low as the VIX averaged 11.4. By comparison, 2018 was much more volatile, with the VIX averaging 16.6. However, this must be taken in context of its historical average, which has been 19.3 since its inception in 1990. So, while 2018 felt frenetic, it was a somewhat average year in terms of volatility.
2018 also felt more volatile because it saw 37 days where the S&P 500 Index was up or down more than 1.5% (nine of which were in December), whereas there were only two days in 2017 when the index moved that much. So when compared to the recent past, 2018 seemed extremely volatile, but over the last twenty years, the S&P 500 has averaged 38 days per year where it was up or down more than 1.5%; again making 2018 look average.
Investors often think about the tradeoff between risk and return and how much they are being rewarded. 2018 was the fifth negative year over the last 20, but in comparison to the other down years, 2018 was less volatile and down less (Figure 4, below). After positive performance in each month of 2017 and exceptionally low volatility, 2018 felt much worse than it really was.
There is no doubt that volatility awoke in 2018 and is likely to persist into 2019, but this is actually pretty normal. Economic fundamentals may be showing some signs of growth slowing in the U.S., but that is to be expected as the Fed tightens and the tailwind from fiscal stimulus fades. Corporate earnings are still expected to grow in 2019 and consumers are relatively confident, with low unemployment and moderate wage growth, which should bode well for the U.S. economy and hopefully the stock market. If any of the multiple uncertainties plaguing the markets (e.g., trade with China, Fed policy, or the government shutdown) can be resolved, the market may finally see some relief.