December 2018

Kai W. Hong, CFA
Managing Partner & Chief Investment Strategist

After three quarters in which a host of geopolitical uncertainties and slowing global economic growth saw investors continue to boost US equities at the expense of everything else, the combination of increasing political dysfunction in the US (culminating with a government shutdown in December) and ongoing and unresolved concerns over trade were finally enough to catalyze a broad-based sell-off in the fourth quarter. The US Fed’s hawkishness only added to the negative sentiment around risk assets. While measures of consumer sentiment were generally positive given modestly rising wages, businesses were beginning to warn more consistently of the negative impacts that the trade disputes were having on current operations and future planning.

Given all of these factors, US markets posted significantly negative results for the fourth quarter, with some entering “bear” territory and others barely staying above. The Russell 3000 Index finished the quarter with a return of -14.3%, one of its worse performances ever. Small cap stocks were particularly hard hit with the Russell 2000 Index returning -20.2% versus the Russell 1000 Index returning -13.8%. Markets outside of the US fared somewhat better, having already posted negative returns for the year so far. The developed market MSCI World ex USA Index returned -12.8% while the developing market MSCI Emerging Markets Index returned -7.5%. Fixed income markets held up much better in the sell-off with the Bloomberg Barclays US Aggregate Index returning +1.6%.

In the US at the Sector level, Energy (-26.3%) was the worst performer for the quarter by far as oil prices fell precipitously on supply and demand concerns. Returns in Technology (-18.2%) and Producer Durables (-18.1%) were also strongly negative. The only relative safe havens in the drawdown were the defensive sectors of Utilities (-3.0%) and Consumer Staples (-6.7%).

Outside of the US, the sectors trends were largely the same. Energy (-16.0%) and Technology (-15.1%) were also the main detractors while Utilities (-3.5%) and Consumer Staples (-7.3%) held up better. At the country level, the best and worst performers were once again found among the smaller markets. Austria (-19.5%) and Greece (-19.2%) led decliners while Brazil (+14.2%) and Indonesia (+11.6%) rallied.

Market volatility jumped significantly during the quarter with implied and actual price volatility measures reaching materially above average levels. At the factor level, Smaller Size and Momentum were both strongly negative while Stability, Yield, Value, and Low Volatility were meaningfully positive. An equal-weighted portfolio underperformed the market-cap weighted portfolio once again as larger cap names outperformed.