Q4 2018 Review banner

2018 Q4 Market Review

Q4 2018 Review banner

What a difference a few months can make. After producing back-to-back quarterly gains in Q2 and Q3, major U.S. equity indexes retrenched in the final three months of 2018. In terms of total returns, the S&P 500 lost 13.53% in Q4 -- much worse than Q1's slight dip.

For the year, the IFA US Large Company Index, which closely tracks the S&P 500, fell 4.42%, marking the first losing year since 2008. Even so, full-year 2018 results hardly played out like 2008's global financial crisis. In that year's steep decline, the IFA US Large Company Index was down 36.8%.

In 2018's fourth-quarter, trading noise and dour financial news headlines built to a crescendo in the days leading up to Christmas. The tech-heavy Nasdaq Composite index during December broke into correction territory. At the same time, the S&P 500 and Dow Jones Industrials index came within whiskers of sinking more than 20% from their highs.  

Traders faced uncertainty about monetary tightening moves by the US Federal Reserve. Just weeks before quarter's end, the Fed Open Market Committee voted to bump up short-term interest rates a quarter-point to a range of 2.25% to 2.50%. This marked the fourth increase for the year by the Fed and ninth since late 2015.

The Institute for Supply Management index fell at year's end to a two-year low, led by the biggest slide in new orders by American companies in five years. Also, production slowed at a pace representing the index's largest fall since 2012. Meanwhile, the Conference Board's index of U.S. consumer confidence dropped for a second-straight month in December.

Declining sentiment came as U.S. tariff negotiations to avoid a protracted trade war with China progressed in fits and starts. National midterm elections saw Democrats take control of the U.S. House of Representatives, threatening more political division in Washington, D.C. A partial government shutdown ensued to close out the year.

The fourth-quarter was even rougher on international stocks. In December, an IHS Market benchmark tracking eurozone service sector output hit its lowest level in more than four years. Other market surveys found that new orders from manufacturers and business sentiment were both slumping by year's end.

Asia and emerging markets were heavily influenced by reports that China's growth was notably slowing. Official government data, released early in 2019, confirmed such fears. By China's own estimates, economic growth in the world's second-largest economy continued to slow in Q4 to wind up 2018 at 6.6%. That might still look fairly good to investors in the U.S. and other developed economies. But it marked China's slowest pace of annual economic expansion since 1990. In terms of Q4, it represented the country's third-straight quarter of ebbing growth.

Domestic Equities

Returns for the different size and style of domestic equities were all negative in Q4 of 2018. The returns ranged from -13.53% for IFA's large-cap blended equities benchmark to -20.15% for IFA's blended domestic small-cap equities index. Meanwhile, stocks as captured in IFA's small-cap value index fell by 20% as its cousin U.S. small-cap growth index ended in the red by -19.30%. When looking at the full-year 2018 results, returns ranged from -3.33% (large-cap growth) to -15.78% (small-cap value). For the domestic equity indexes used in IFA portfolios, the quarterly return was -17.85% for Q4.

Returns of IFA Domestic Equity Index -q4-2018

International (Developed) Equities

IFA index returns from developed countries that are outside the United States all fell into negative territory in Q4 of 2018. In the quarter, results ranged from -14.63% for large-cap international value equities to -17.91% for international small company value stocks. When looking at the full-year 2018 results, returns ranged from -17.49% (international value) to -23.31% (international small-cap value). For the blend of international indices used in the IFA Index Portfolios, the return was -16.36% in Q4. 

Return of IFA International Equity Indexes - Q4-2018

Emerging Markets Equities

Emerging Markets had a down quarter. For Q4, EM returns ranged from a loss of 5.70% for emerging markets small-cap equities to -7.17% for emerging markets large-cap value equities. By comparison, full-year 2018 returns ranged from -17.56% (emerging markets small-cap equities) to -11.93% (emerging markets large-cap value equities). For the blend of emerging markets indices used in IFA Index Portfolios, the return for Q4 was -6.53%. 

Return of IFA Emerging Markets Equity Index-Q4-2018

Real Estate Equities

Global real estate was a picture of the broad benefits of diversification. In the fourth-quarter, international real estate stocks returned -4.70%. Domestic REITs returned -5.15%, providing the IFA Global Real Estate Index with a -4.93% blended return in Q4.

Returns of IFA Real Estate Index-q4-2018

Fixed-Income

Interest rates in U.S. income markets moved inversely during Q4, resulting in a change in return for our fixed income positions. In the fourth quarter, the 30-year U.S. Treasury rate increased by 22 basis points while the five-year U.S. Treasury rate decreased by 45 basis points.

For Q4, the four bond funds used by IFA delivered returns ranging from 0.78% for One-Year Fixed Income to 1.54% for Short-Term Government Fixed-Income. For the blend of fixed income used in the IFA Index Portfolios, the return was a positive 1.13% for Q4. If interest rates have risen, the price of existing bonds at lower rates will decrease so that new buyers of the bonds can get the same total return (capital gains plus interest) as that available from newly issued bonds at the higher rate and at similar risk.

Returns of IFA Fixed Income Indexes-q4-2018

 

IFA Index Portfolios

The returns of the IFA index portfolios are shown below net of the maximum annual 0.90% advisory fee through Dec. 31, 2018. You can see that slighly more than the entire loss for the year occurred in Q4. 

Returns of IFA Index Portfolios-q4-2018

What investors need to keep in mind is that there will always be short periods in which their IFA Index Portfolios will have negative returns. How long those periods have lasted was tied to the amount of risk in the portfolio. This is the very nature of risk and the reason investors earn a return.

Given the recent underperformance in U.S. value stocks as compared to growth stocks in both large and small companies, some IFA clients may be wary about their tilt toward small and value companies. The chart below shows monthly rolling period returns of the IFA U.S. Small Cap Value Index versus the IFA U.S. Large Cap Growth Index for the last 50 years. Over monthly periods, it has been a toss up between Large Cap Growth and Small Cap Value. But once we expand our view to longer time horizons, you can see that small value was the better index to own. 

Each quarter, IFA monitors the funds they recommend for clients and as part of that process, we’ve developed a rating system. Below is a link to our Performance Monitoring Report for client portfolios: IFA Fourth Quarter 2018 IFA Client Performance Monitoring Report.

We've created the Investing Kit that includes a copy of "Index Funds: The 12-Step Recovery Program for Active Investors" book and documentary film based on the book, as well as the Galton Board, Stock Market Edition, which simulates the distribution of 600 monthly returns right before your very eyes. You can find the Investing Kit on Amazon.