Uncle Sam stole the year-end Santa rally. The worst December since 1931 and the worst Christmas Eve stock market performance of all time occurred this year. From my perspective, it is all politics this December. Yes, our great Uncle Sam “Scrooge” stole Christmas and a small positive investment performance for 2018. It traces to bad politics coming together in a “perfect storm.” A “perfect political storm” is the coming together of at least 2 bad events at the same time. We count at least 3 negative political charges right now: the Fed, Tariffs, and government shutdown (budget).
With just 5 trading days remaining in 2018, Santa is missing, failing to deliver any holiday cheer more familiar to investors at this time of year. Even a lump of coal might feel better at this point. Instead, the ill-behavior of financial markets would suggest that something very bad is happening to the global economy. On the heels of a -1.2% slide during the week ended December 14, the selloff intensified with the S&P tumbling another –7.0% for the week. It was the worst week for US equities in 10 years, and stocks are now off more than -12% for the month. Smaller-size US companies are generally faring even worse with the Russell 2000 small-cap index down -15% for the month and crossed the bear market threshold of -20% from its peak. The tech-heavy Nasdaq is also officially closed in bear territory on Friday (12/21) from its peak after leading the charge throughout most of the last two years. But regardless of size, US stocks are decidedly negative for 2018 to varying degrees.
Barron’s front cover over the weekend (12/15/2018) read “2019 Outlook: US Stocks Could Rally More Than 10%”; while the New York Times front page (12/15/2018) was “The Best Place to Put Money? Your Mattress” and in the Style Section (same paper/date) read “Are You Ready for the Financial Crisis of 2019?” Quite divergent headlines on the same day.
As we noted in these pages at the beginning of last week, we find it simply remarkable how quick the market’s mood can change against a fluid and stressed environment like the recent two months. Entering the week, the stars seemed to be aligning for those hopeful a more dovish Fed and collaborative tone between the US and China over ongoing friction about trade might develop. As recent as last Monday, optimists were starting to feel as if the storm clouds were receding during the final week of November, and a much longed-for Santa Rally in December might be starting to take shape. Then, with seemingly little warning, the bears were awakened again with declines throughout the balance of the week. The carnage began to unfold Tuesday, with blame by the media mostly being attributed to investors having second thoughts about the trade truce with China, although less recognized was a troubling development in Europe with British Prime Minister May suffering a setback in her government and undermining the Brexit proposals. We also believe that the inversion of the yield curve among some shorter maturities likely triggered indiscriminate and heavy risk-off program selling of US equities exacerbating any fundamental concerns. Despite the tail end of a strong multi-day rally on Monday, and the market being closed in honor of the passing of the 41st President Bush on Wednesday, the major US indexes still found themselves -4.6% in the hole to conclude the first week of December. From a psychological standpoint, the market backdrop is feeling increasingly pessimistic. Most challenging however is for investors to try and keep in mind how quickly the environment could take a turn for the better again seeing as how so many of the worries are “man-made” and policy-related.
All the historical hype surrounding favorable mid-term election year investment returns is yet to materialize as we conclude 2018. Since 1950, every mid-term election (17 of them) resulted in strong end-of-year stock performance because the unknown of political change concluded. A different stock market stat, again since 1950, reflects that 75% of December returns are positive; that is the highest single month probability of upward performance for any of the 12 months (next highest is April at 71%, and November with 68% of the time being positive – see chart below). This year, the 4Q experience to-date seems stark opposite.
In our November market commentary entitled “Shake or Break”, as well as periodic updates in recent weeks, we’ve spoke extensively about how the market’s October swoon and elevated volatility were not without justification. The sudden awakening by investors following conclusion of the 3Q can be linked to persistent worries that the economic strength being witnessed in the US for 2018 might be “as good as it gets”, set to fade as we anniversary tax reform; when paired with the lack of constructive progress between Trump and China over trade and the Fed communicating in a way that felt decreasingly data-dependent and instead on autopilot with respect to additional interest rate hikes it makes sense why so many market participants were in bad moods. We’ve stated throughout the duration of this corrective phase that the economic data in the US remained supportive and the probability of recession in the near-term would still appear remote. But the financial markets needed to quickly see a more conciliatory tone begin to develop from both Trump and Fed Chairman Powell before further psychological confidence damage and any meaningful stock market recovery could develop. That’s exactly what we received last week and financial markets responded strongly with their best week in two years.