2018, especially the fourth quarter, was a challenging year for stocks with both the United States (U.S.) and international stock markets posting negative returns. Despite a robust U.S. economy, the market fixated on future concerns related to tighter monetary policy, trade tensions, declining oil prices, the U.S. government shutdown and slowing global growth.
In December, the Federal Reserve followed through on its plan to raise interest rates four times in 2018, given the strength of the U.S. economy. Over the course of the year, the U.S. economy added 2.64 million jobs, the third-best year for job growth since 2008. In December alone, the economy added 312,000 jobs, which was almost double the amount many economists had predicted.1 The unemployment rate climbed to 3.9%2 in December (from 3.7% in November), due to higher labor force participation rates, but it’s still the lowest year-end reading since December 2000.
By year end, the U.S. and China appeared to be making some progress on the trade front, as the two countries entered a trade truce and restarted talks; however, doubts remained about whether they would reach an agreement.
Fourth Quarter 2018 Returns3
Returns shown in the chart above are for fourth quarter 2018.
After rallying for the majority of the year, the U.S. equity market retreated in the fourth quarter, seemingly unsettled by the December Fed-rate increase and U.S.-China trade tensions. U.S. large-cap stocks, represented by the S&P 500 Index, were down 13.5%, erasing all of the gains they accumulated in prior quarters; they ended in negative territory for the year (-4.4%). Large-cap growth stocks, represented by the Russell 1000 Growth Index (-15.9%), underperformed value stocks (Russell 1000 Value Index, -11.7%) during the quarter, but they outperformed for the year (-1.5% vs. -8.3%). Small-cap stocks underperformed large-cap stocks for both the quarter and the full year.
We continued to see headwinds in the international-developed and emerging markets. International-developed stocks, represented by the MSCI EAFE Index, declined 12.2% in local currency terms and 12.5% in USD terms, with uncertainty around Brexit at the forefront of investors’ concerns. The strong dollar had a larger negative impact on performance for the year, as the MSCI EAFE Index was down 11.0% in local currency terms and 13.8% in USD terms. In emerging markets, trade tensions between the U.S. and China continued to weigh heavily — last quarter, the MSCI Emerging Market Index was down 7.4% in local currency terms (-10.1% for the full-year 2018) and 7.5% in USD terms (-14.6% for the full-year 2018).
World Asset Classes4
Returns for the Fourth Quarter and Full Year 2018
On the fixed-income side, the Federal Reserve increased the short-term interest rate for the fourth time in 2018 by 25 basis points (bps), bringing the benchmark federal-funds rate to a range between 2.25% and 2.5%. This is the ninth rate hike since December 2015 — however, the Fed has indicated it will take a slower rate-hiking pace in 2019. Since the end of third quarter 2018, the 2-year Treasury yield fell from 2.81% to 2.48%, and the 10-year Treasury yield fell from 3.05% to 2.69%. As yields fall, bond prices rise — the Bloomberg Barclays Aggregate Index, representing investment-grade U.S. bonds, was up by 1.6% for the quarter, but flat for the year (+0.0%). Municipal bonds, represented by the BBgBarc Municipal 1–10Y Index, were one of the few positive segments of the market, gaining 1.6% for the quarter and the year.
Emerging-markets bonds posted the strongest performance among asset classes for the quarter, with the JPM GBI-EM Global Diversified Index (UH), which represents local currency bonds issued by emerging-market governments, returning +2.1%. Despite the strong fourth-quarter performance, the index was down 6.2% for the year due in large part to emerging-market currency weakness earlier in 2018. High-yield bonds, represented by the ICE BofAML BB-B US CP HY Index, also suffered as investors’ appetite for risk diminished. High-yield bonds ended the quarter down by 3.9%, and they declined 2% for the full-year 2018.
The market tumult we experienced in 2018 was especially unsettling since it was preceded by calm markets and strongly positive global equity returns in 2017. A disciplined investment approach calls for staying the course through difficult years such as 2018 and looking beyond the short-term market noise to the long-term investment prospects presented across the globe.
The fourth-quarter equity market decline has many investors wondering how equities may perform in the near term. One of the mistakes investors make is allowing recent underperformance to color their view of the future and changing their investments based on these short-term events. Equity-market declines of 10% have occurred numerous times in the past. Although both U.S. stocks and international stocks logged double-digit negative declines in the fourth quarter, it is important to remember that after declines of 10% or more, equity returns over the subsequent 12 months have been, on average, positive 71% of the time in U.S. markets and 72% of the time in other developed markets.5
With a difficult year in the markets behind us, we encourage you to remain steadfast in your investment strategy and in the words of famed investor Warren Buffett: “Be fearful when others are greedy and greedy when others are fearful.”
U.S. Stock Market: Russell 3000 Index
International-Developed Stocks: MSCI EAFE NR Index
Emerging-Markets Stocks: MSCI EM NR Index
U.S. Bond Market: Bloomberg Barclays Aggregate Index
Emerging-Markets Bonds: JPM GBI EM Global Divers TR Unhedged
Return data represent past performance and are not indicative of future results. Historical returns of indices do not reflect applicable transaction, management or other applicable fees, the incurrence of which would decrease historical performance results. Index information has been compiled by Wipfli Financial from sources Wipfli Financial deems reliable, but has not been independently verified. Historical performance results for investment indices and/or categories have been provided for general comparison purposes only. Indices are unmanaged. It is not possible to invest directly into an index. Any charts and graphs represented herein are for informational purposes only and cannot in and of themselves be used to determine which securities to purchase or sell, or when to purchase or sell securities.
Source for all return data: ©  Morningstar. All Rights Reserved. The information contained herein: (1) is proprietary to Morningstar and/or its content providers; (2) may not be copied or distributed; and (3) is not warranted to be accurate, complete or timely. Neither Morningstar nor its content providers are responsible for any damages or losses arising from any use of this information. Past performance is no guarantee of future results.