Published by Manulife Securities Investment Services Inc. on Jan 16, 2019
2018 was the weakest year for global markets since the great financial crisis in 2008. Markets were dragged down substantially in the final three months of the year due to higher interest rates, a slowing global economy, U.S. government shutdown and continued trade tension between the United States and China. Equity markets can move up or down for many reasons but over the long term, market valuations tend to return to their fundamentals. However, the fundamentals during the past year do not justify the sell-off that we’ve experienced, which suggests that the worst may be behind us.
Long-term investors who stay the course will likely be rewarded in 2019.
The S&P/TSX Composite was down 11.6 percent in 2018, driven by lower energy prices and negative market sentiment. A resolution to the North American Free Trade Agreement (NAFTA) in November couldn’t spare the Canadian index as oil, as measured by the West Texas Intermediate (WTI), fell nearly 25 percent due to increased supply driven by the United States. Although energy was the worst performing sector, the sell-off was widespread across the S&P/TSX. Eight out of ten sectors were negative for the year.
The United States
U.S. equity markets were down for 2018. The S&P 500, Dow Jones and Nasdaq were down 6.2, 5.6 and 3.9 percent respectively. One reason for the weak equity markets was a strong US economy that led to four interest rate increases of 25 basis points each. These interest rate hikes have caused concern that higher rates may dampen credit growth and company earnings in the future. Employment continued to improve in 2018 and the unemployment rate dropped from 4.1 percent to 3.9 percent.
In overseas markets, international equities fell 16.1 percent in U.S. dollars as measured by the MSCI EAFE Index. Overseas markets were driven lower due to negative market sentiment, a slowing global economy and political risks surrounding Brexit. China’s weakening economy, which was affected by tightening financial conditions and trade tensions, was a focus for investors.
Central Bank Policy
In 2018, the Bank of Canada increased its interest rate to 1.75 percent by announcing three rate increases of 25 basis points each. In 2019, it’s expected rates will increase very gradually. The Bank of Canada will wait to see the effect on the economy of the previous hikes, high consumer debt levels and the impact of lower energy prices. Interest rates remain the highest since December 2008.
The U.S. Federal Reserve raised its overnight rate four times from 1.25 percent to 2.25 percent in 2018 and lowered their forecasts for interest rate hikes in 2019 amid recent market volatility and slowing global growth. A U.S. interest rate cycle that’s likely near its end would be positive for global economies and markets since the cost of borrowing will grow more slowly.
Although the sell-off didn’t quite meet the definition of a bear market, from an investment perspective it felt like it. Sell-offs of this magnitude are caused by recessions or negative sentiment, with the latter usually resulting in a subsequent rebound in the near term. Yes, global economies have slowed, but none of the traditional elements of a recession (employment, housing, manufacturing) appear today, which indicates that the risk of a recession over the coming year has not increased materially. Long-term investors who stay the course will likely be rewarded in 2019.
Photo credit: Pixabay