With 2018 in the books, it's good to take a step back and analyze what transpired. It's safe to say 2018 was one of the more challenging years since the "great recession". While it provided less volatility compared to 2008, navigating equity and bond markets proved challenging because of rising interest rates (less accommodative federal reserve), a looming trade war and the possibility of a slowing global economy.
As discussed in our October market commentary, diversification has been a drag on portfolio returns as a majority of bond and equity indices underperformed the S&P 500 since March. Since 1928, there have been three occasions where the S&P 500 & 10 year U.S. treasury posted negative returns in the same year. Baring a monumental recovery in the last few trading days of the year, this will be the fourth. This is quite the contrast from what we witnessed in 2017 where equity markets experienced some of the lowest levels of volatility in history.
Amongst the volatility, there were several bright spots in the 4th quarter. Diversification has shown signs of life as emerging market equities and some European markets have outperformed the U.S. A majority of bond sectors posted their best quarterly returns for the year. It's important to remember that it is not only equities that experience a wide variance of returns; this applies to bonds as well. Each bond sector carries its own risk ranging from credit, duration and entity exposure that significantly impacts their respective annual returns. Years such as 2008, 2011 and 2013 illustrate the large variance of bond returns. Many bonds show their true value in periods of stock market volatility. It takes dedication and discipline to ride out an increase in volatility because it can sometimes take years to see meaningful benefits. When analyzing a portfolio, it is important to look at the total and not focus on an individual holding as a properly diversified portfolio should always have investment with varying degrees of expected return to help mitigate volatility.
Markets never provide an all-clear signal, so investors must understand that volatility is a normal part of investing. We expect much of the same for 2019. This does not imply that markets will end lower, but investors should prepare themselves mentally as many issues are yet to be resolved and volatility tends to increase in periods of uncertainty. Equity markets are a great source of wealth creation, but that wealth can be significantly reduced if one is not diversified and disciplined.
Wishing you a Happy and Healthy New Year!