Market Update for the Month Ending December 31, 2018

Posted January 4, 2019

Terrible December caps off tough year for markets
Unfortunately, investors who were holding out hope for a year-end rally were disappointed. As 2018 came to its end, rising political and economic concerns weighed on global markets. This turmoil capped off a disappointing quarter and year for equities.

Among U.S. markets, the Nasdaq Composite fared the worst. It saw losses of 9.40 percent for the month and 17.29 percent for the quarter. For the year, though, the Nasdaq was down only 2.84 percent. The Dow Jones Industrial Average had similar results. It lost 8.59 percent for the month and 11.31 percent for the quarter, contributing to a loss of 3.48 percent for the year. Finally, the S&P 500 declined by 9.03 percent in December. This led to a drop of 13.52 percent for the quarter and 4.38 percent for the year.

December’s selloff resulted from concerns over the government shutdown, among other political worries. All three U.S. indices remained below their 200-day moving averages. As such, investors’ long-term outlook on U.S. equities may be turning more negative. But even with the recent volatility, there is reason for some optimism.

Fundamental earnings growth continues to be supportive for equities. According to FactSet, the estimated earnings growth rate for the S&P 500 in the fourth quarter is 12.4 percent (as of December 21, 2018). Although down from the third quarter, this result would represent the fifth straight quarter of double-digit earnings growth. Fundamentals drive performance. So, this double-digit growth is reassuring in the face of recent selloffs. From a valuation perspective, the current S&P 500 forward 12-month price-to-earnings ratio is now below its 5- and 10-year moving averages, indicating that the index is relatively inexpensive compared with the recent past.

International markets also had a volatile end to the year. Here, concerns surrounding slowing growth in China and the ongoing Brexit negotiations hit markets. The MSCI EAFE Index declined by 4.85 percent for the month, 12.54 percent for the quarter, and 13.79 percent for the year. The MSCI Emerging Markets Index saw losses of 2.60 percent, 7.40 percent, and 14.25 percent over the same time periods. Technically, both indices remained well below their respective 200-day moving averages.

Fixed income had a better end to 2018, although the annual results were disappointing. The Bloomberg Barclays U.S. Aggregate Bond Index gained 1.84 percent in December and 1.64 percent in the fourth quarter, as rates fell to end the year. The 10-year U.S. Treasury yield was very volatile in 2018. It started the year at 2.46 percent, hit a high of 3.24 percent in November, and finished the year at 2.69 percent. But the large decline in yields at year-end was barely enough to offset earlier volatility. In fact, the index eked out a gain of only 0.01 percent for the year. The Federal Reserve (Fed) raised rates three times in 2018, as the unemployment rate remains at multidecade lows and inflation measures are above the Fed’s target range.

High-yield fixed income, which is typically less affected by rates, had a rough end to the year. It saw a loss of 2.14 percent in December, leading to a quarterly loss of 4.53 percent and an annual loss of 2.08 percent. High-yield spreads have spent the past two years largely range bound. But they increased dramatically in December, as investors reevaluated the risk-and-reward potential for the asset class.

Economic growth continues
Financial markets do not define the economy. So, despite the past few months of market volatility, the economy remains solid. When we look at the economic fundamentals, there is still reason for optimism as we head into 2019.

The driver of the current expansion, the U.S. consumer, continues to make and spend more money. High levels of consumer confidence showed that shoppers were willing to spend. Indeed, we have seen solid growth in retail sales for the past two months, including the important holiday season. Personal income and wage growth in November were also healthy. These solid results suggest that spending growth is sustainable.

Business owners also remain confident in the economy. Both the manufacturing and nonmanufacturing sentiment surveys increased in November. These increases came against expectations for modest declines. As you can see in Figure 1, the Institute for Supply Management Composite Index shows confidence near postrecession highs.

Figure 1. Institute for Supply Management Composite Index, 2007–2018


This strong sentiment is encouraging. High confidence levels have historically led to higher spending, which helps grow the economy. Real data supported these high confidence levels, as businesses also continued to spend to end the year. November’s durable goods orders, often used as a proxy for business investment, rose by a solid 0.8 percent on increased aircraft orders. Industrial production also increased in November. Here, though, some cold weather effects likely made this growth figure look better than it actually was.

The good news is that business sentiment and investment are positive. Unfortunately, this is not true for one of the other major sectors of the economy: housing.

Housing slowdown continues
The housing sector continued to disappoint to end the year. Home builder sentiment, which collapsed in November, continued to drop. Pending home sales, which were expected to increase modestly in November, fell by 0.7 percent instead. That said, housing starts actually rose last month, against an expected decline. So, the slowdown may be moderating.

Going forward, we do see signs of optimism for housing. An unexpected increase in existing home sales may indicate a moderating slowdown. Further, slowing sales have led to more inventory, which could lead to lower prices and increased activity. Lower mortgage rates will also help. Given the many knock-on effects that housing spending generates, this will be an important area of the economy to watch as we start 2019.

Government shutdown highlights political risks
Of course, economic worries are real. But what absolutely hit markets in December was politics. The month started with a spat between the Fed and the White House over rising interest rates. It ended with a confrontation between Congress and the White House, resulting in the current government shutdown.

Either of these conflicts would have rattled markets. But both in one month did real damage. Fortunately, there appears to be no true threat to Fed independence. And while a government shutdown is certainly worth paying attention to, historically, the impact of a short-term shutdown on economic growth has been minimal. There is even some potential upside here. If congressional leaders and the president can find a compromise, it would likely help markets recover.

There were political risks outside the U.S. as well. The trade war with China rumbled on, raising fears of an economic slowdown there. Plus, the British political debacle around Brexit rattled European markets.

Once again, markets are now pricing in terrible outcomes. But there is the potential for positive events to lead to a market rally. The resumption of trade talks between the U.S. and China in January is just one example of a potential tailwind. In Europe, more clarity on Brexit would likely lead to a rally in those markets.

Risks remain, but U.S. outlook remains strong
Heading into 2019, there are still areas of the economy worth monitoring. But on the whole, things look pretty good here in the U.S. Our economy continues to expand at a healthy pace, driven by confident consumers and business owners spending more. Corporate fundamentals also remain strong. Although the effects of tax reform may moderate, continued deregulation should help support these results.

As we have seen this year, risks certainly still remain, even in a good economic environment. Political risks are likely to drive volatility in 2019—but it is anyone’s guess as to how and when. Given the volatile times we are in, a well-diversified portfolio matched with an investor’s time horizon remains the best path to ride out turbulent times and meet financial goals.

Co-authored by Brad McMillan, managing principal, chief investment officer, and Sam Millette, fixed income analyst, at Commonwealth Financial Network.

All information according to Bloomberg, unless stated otherwise. 

Disclosure: Certain sections of this commentary contain forward-looking statements based on our reasonable expectations, estimates, projections, and assumptions. Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict. Past performance is not indicative of future results. Diversification does not assure a profit or protect against loss in declining markets. All indices are unmanaged and investors cannot invest directly into an index. The Dow Jones Industrial Average is a price-weighted average of 30 actively traded blue-chip stocks. The S&P 500 Index is a broad-based measurement of changes in stock market conditions based on the average performance of 500 widely held common stocks. The Nasdaq Composite Index measures the performance of all issues listed in the Nasdaq Stock Market, except for rights, warrants, units, and convertible debentures. The MSCI EAFE Index is a float-adjusted market capitalization index designed to measure developed market equity performance, excluding the U.S. and Canada. The MSCI Emerging Markets Index is a market capitalization-weighted index composed of companies representative of the market structure of 26 emerging market countries in Europe, Latin America, and the Pacific Basin. It excludes closed markets and those shares in otherwise free markets that are not purchasable by foreigners. The Bloomberg Barclays Aggregate Bond Index is an unmanaged market value-weighted index representing securities that are SEC-registered, taxable, and dollar-denominated. It covers the U.S. investment-grade fixed-rate bond market, with index components for a combination of the Bloomberg Barclays government and corporate securities, mortgage-backed pass-through securities, and asset-backed securities. The Bloomberg Barclays U.S. Corporate High Yield Index covers the USD-denominated, non-investment-grade, fixed-rate, taxable corporate bond market. Securities are classified as high-yield if the middle rating of Moody's, Fitch, and S&P is Ba1/BB+/BB+ or below.



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Year-End Financial Planning Checklist

As 2018 draws to a close, it’s time to begin organizing your finances for the new year. To help you get started, we’ve put together a list of key planning topics to consider.

Savings and investments

Revisit your retirement contributions. Review how much you’re contributing to your workplace retirement account. If you’re not taking full advantage of your employer’s match, it’s a great time to consider increasing your contribution. If you’ve already maxed out your match or your employer doesn’t offer one, boosting your contribution could still offer tax advantages. Now is also a good time to ensure that your portfolio allocation remains in line with your objectives.

Take stock of your goals. Did you set savings goals for 2018? Realistically evaluate how you did, and think about your goals for next year. If you determine that you are off track, we’d be happy to help you develop and monitor a financial plan.

Health and wellness

Spend your flexible spending account (FSA) dollars. If you have an FSA, those funds may be forfeited if you don’t use them by year-end. (Some FSAs offer a 2.5-month grace period or the ability to carry over up to $500 into the next year; check with your employer to see if those options are available.) It’s also a good time to calculate your FSA allotment for next year, based on your current account excess or deficit.

If you’re not using an FSA, evaluate your qualifying health care costs to see if establishing one for 2019 would make sense.

Taxes, taxes, taxes

Manage your marginal tax rate. If you’re on the threshold of a tax bracket, deferring income or accelerating deductions may help you reduce your tax exposure. It might make sense to defer some of your income to 2019 if doing so will put you in a lower tax bracket. Accelerating deductions, such as medical expenses or charitable contributions, into the current tax year (rather than paying for deductible items in 2019) may have the same effect. In addition, reviewing your capital gains and losses may reveal tax planning opportunities—for instance, harvesting losses to offset capital gains.

Here are a few key 2019 tax thresholds to keep in mind:

  • The 37-percent marginal tax rate affects those with taxable incomes in excess of $510,300 (individual), $612,350 (married filing jointly), $510,300 (head of household),
    and $306,175 (married filing separately).

  • The 20-percent capital gains tax rate applies to those with a taxable income in excess of $434,550 (individual), $488,850 (married filing jointly), $461,700 (head of household),  and $244,400 (married filing separately).

  • The 3.8-percent surtax on investment income applies to the lesser of net investment income or the excess of modified adjusted gross income over $200,000 (individual), $250,000 (married filing jointly), $200,000 (head of household), and $125,000 (married filing separately).

Consider the benefits of charitable giving. Donating to charity is another good strategy for reducing taxable income. If you’d like to help a worthy cause while trimming your taxes, it’s worth exploring your charitable goals and various gifting alternatives.

Make a strategy for stock options. If you hold stock options, now is a good time to make a strategy for managing current and future income. Consider the timing of a nonqualified stock option exercise. In light of your estimated tax picture, would it make sense to avoid accelerating income into the current tax year or to defer income to future years? And don’t forget about the alternative minimum tax (AMT). If you’re considering exercising incentive stock options before year-end, have your tax advisor prepare an AMT projection to see if there’s any tax benefit to waiting until January of the following year.

Plan for estimated taxes and required minimum distributions (RMDs). When considering your taxes for 2018, be sure to take any potentially large bonuses or a prosperous business year into account. You may have to file estimated taxes or increase the upcoming January payment. If you’re turning 70½, you’ll need a strategy for taking RMDs from your traditional IRA and 401(k) plans.

Adjust your withholding. If you think you may be subject to an estimated tax penalty, consider asking your employer (via Form W-4) to increase your withholding for the remainder of the year to cover the shortfall. The biggest advantage of this is that withholding is considered as having been paid evenly throughout the year instead of when the dollars are actually taken from your paycheck. You can also use this strategy to make up for low or missing quarterly estimated tax payments.

Proactive planning

Review your estate documents. To help ensure that your estate plan stays in tune with your goals and needs, you should review and update it on an ongoing basis to account for any life changes or other circumstances. If you haven’t done so during 2018, take time to:

  • Check trust funding

  • Update beneficiary designations

  • Take a fresh look at trustee and agent appointments

  • Review provisions of powers of attorney and health care directives

  • Ensure that you fully understand all of your documents

Check your credit report. It’s important to monitor your credit report regularly for suspicious activity that could indicate identity theft. Federal law requires that each of the nationwide credit reporting companies (Equifax, Experian, and TransUnion) provide you with a free copy of your report every 12 months, at your request. 

Get professional advice. Of course, this list is far from exhaustive, and you may have unique planning concerns not covered here. As you prepare for the coming year, please feel free to reach out to us to discuss the financial issues and deadlines that are most relevant to you.

Whatever your planning may entail, we wish you a happy, healthy, and prosperous 2019!

This material has been provided for general informational purposes only and does not constitute either tax or legal advice. Although we go to great lengths to be sure our information is accurate and useful, we recommend that you consult a tax preparer, professional tax advisor, or lawyer.