Data as of December 31, 2018
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The major indexes suffered their worst quarterly declines in roughly a decade, returning most benchmarks to levels last seen in the summer of 2017 and sending them into bear market territory, or down more than 20% from their recent highs. Stocks were also especially volatile, with the S&P 500 Index recording intraday swings of more than 1% on four out of five trading days—with 10 days seeing swings over 3%. Plunging oil prices caused the energy sector to be the worst performer in the S&P 500 Index, falling by nearly 24% on a total return basis. Technology, industrials, and consumer discretionary shares were also exceptionally weak, while the typically defensive utilities sector was the sole segment to escape with a small gain.
Rising Yields Worry Investors Early in the Quarter…
Sentiment was poor throughout most of the quarter, but the reasons for investors’ discontent appeared to shift markedly. Early in the quarter, the market’s losses seemed to be driven by concerns that the U.S. economy was in danger of overheating, which would lead the Federal Reserve to quicken or extend its pace of interest rate increases to fight off inflation. At the start of October, stock prices fell as longer-term bond yields jumped, with the yield on the benchmark 10-year Treasury note reaching 3.25%, its highest level since the summer of 2011. Higher bond yields threaten to increase corporate borrowing costs while making equity dividends less appealing in comparison.
The rise in yields appeared to be driven in part by comments from Federal Reserve Chairman Jerome Powell, who told an interviewer that interest rates were still “a long way” from a neutral level that neither stimulates nor restricts economic growth. Indeed, economic data released early in the quarter were generally robust. Most notably, the Institute for Supply Management’s gauge of service sector activity jumped in September to its highest level since the Institute began collecting data a decade ago, and October payroll gains easily outstripped expectations. Investors also appeared worried about a rise in producer price inflation, although consumer inflation remained moderate.
|Dow Jones Industrial Average||-11.31%||-3.48|
|S&P 500 Index||-13.52||-4.38|
|Nasdaq Composite Index||-17.54||-3.88|
|S&P MidCap 400 Index||-17.28||-11.08|
|Russell 2000 Index||-20.20||-11.01|
Past performance is not a reliable indicator of future performance.
Note: Returns are for the periods ended December 31, 2018. The returns include dividends based on data compiled by T. Rowe Price, except for the Nasdaq Composite, whose return is principal only. Frank Russell Company (Russell) is the source and owner of the Russell index data contained or reflected in these materials and all trademarks and copyrights related thereto. Russell® is a registered trademark of Russell. Russell is not responsible for the formatting or configuration of these materials or for any inaccuracy in T. Rowe Price Associates’ presentation thereof.
…But Yields Later Drop Sharply as Slowdown Fears Emerge
Yields soon reversed course alongside the economic outlook, however. Weekly jobless claims began climbing in November, and retail spending data released in the month proved disappointing. Evidence also accumulated that capital expenditures were slowing—defying hopes that the previous year’s tax cuts would spark a boom in business investment. Meanwhile, rising mortgage rates appeared to be taking a toll on the housing sector. New home sales fell sharply in October, and price increases appeared to be moderating. Data also showed significant slowdowns in China and Europe, and investors worried that the sharp drop in oil prices—which declined by more than 35% in the quarter—indicated underlying weakness in the global economy.
Initially, investors seemed to welcome the moderation in economic growth given the prospects for a more benign turn in monetary policy. In a speech on November 28, Fed Chair Powell stated that official short-term rates were now “just below” a neutral level that would neither stimulate the economy nor rein it in to control inflation. Markets jumped in response, helping send the S&P 500 Index to its best weekly gain in nearly seven years.
Yield Curve Partially Inverts, Raising Recession Fears
Another round of disappointing data in December seemed to tip the mood on Wall Street, however. Stocks fell sharply following the December 7 release of the November payrolls report, which came in below expectations. Poor capital goods data and weakening regional manufacturing surveys seemed to confirm a slowdown in business investment. Investors also focused on a phenomenon that has previously signaled an oncoming recession—in early December, the Treasury yield curve partially inverted, with the yield on the two-year Treasury note higher than that on the five-year note. T. Rowe Price managers observe that inversions can precede recessions by many months or even years, however, and recent central banks’ efforts to suppress long-term interest rates may currently be making yield curve inversions less reliable as a recession indicator.
Hopes that the Fed would substantially curtail its monetary tightening in response to the weaker data were dashed when the central bank policy committee met in mid-December. The Fed raised interest rates for the fourth time in 2018, but more disappointing to investors seemed to be only a modest softening in policymakers’ outlook for 2019, with a majority of Fed officials still expecting two more quarter-point rate increases in the new year. President Trump announced his displeasure with the Fed’s action in a series of tweets, and rumors surfaced that he was exploring replacing Powell—a turn that also appeared to unsettle markets.
Government Shutdown Adds to Worries
Indeed, the tumultuous policy environment in Washington appeared to bear much of the blame for the bleak mood on Wall Street. The indexes experienced many of their worst declines late in the quarter, following the partial shutdown of the federal government at midnight on Friday, December 21. Treasury Secretary Steven Mnuchin attempted to calm markets by issuing a press release over the following weekend, announcing that executives of the nation’s leading banks had assured him that they were not suffering any liquidity problems because of the turbulence in financial markets. By raising a concern that had not been apparent to most investors, however, his reassurances seemed to have the opposite effect, and stocks plunged again when the market reopened the following Monday.
Meanwhile, concerns about a deepening U.S.-China trade war seemed to weigh on markets throughout the quarter. In October and November, investors worried about the looming end-of-year deadline set by the Trump administration, when the tariff rate on Chinese goods would rise from 10% to 25% absent substantial progress in talks. Markets spiked on December 3, following an announcement from the White House that it was postponing the hike by 90 days following talks between Presidents Trump and Xi at a summit meeting the previous weekend. Stocks then suffered their second-worst day of the quarter on December 4, however, following a series of tweets from the president in which he questioned whether a “real deal” was possible with China and referred to himself as a “Tariff Man.” The trade outlook brightened a bit again as the quarter came to an end with the president tweeting that he had made “big progress” on a call with the Chinese leader.
No Boom Means Bust Is Unlikely
While overall global growth is likely to slow in 2019, T. Rowe Price managers generally do not anticipate a recession in the U.S. and expect some rebound in European and Chinese growth. The Fed has completed most of its anticipated tightening, making further rate hikes less of a challenge. The auto and housing sectors in the U.S. have slowed as rates have risen, but the types of distortions that are typically apparent at the end of a market cycle are conspicuously absent—providing little threat of a boom being followed by a bust. The current environment has not seen a widespread misallocation of capital and euphoria in certain sectors, such as occurred in telecom infrastructure in 1999 and housing in the mid‑2000s.
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The views contained herein are those of the authors as of January 2019 and are subject to change without notice; these views may differ from those of other T. Rowe Price associates.
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