The 2018 Market and Economic Review
Almost everyone’s 2018 predictions were wrong.
But that’s almost always the case. We had another year of unexpected and startling changes in the economy and markets.
Trends couldn’t have been much better than they were at the end of 2017. The economy was surging across the board, and U.S. stock indexes were moving steadily higher. All this happened even though the Federal Reserve was tightening monetary policy.
Economic growth continued into 2018, thanks at least in part to the stimulus from the Tax Cuts and Jobs Act enacted in late 2017. The recovery from the financial crisis now is the second-longest economic expansion since 1900, eclipsed only by the 1990s expansion. This economic cycle will be the new leader if growth stays positive through the first half of 2019.
Despite the length of the expansion, the rate of growth remains well below average.
More importantly, growth peaked in the first half of the year and has been declining steadily. Housing has been rolling over most of the year. Sales of both new and existing homes declined and now are at or near multi-year lows.
Auto sales peaked in the fall of 2017 with a sales rate of 18.5 million annualized. That surge was partly due to people replacing the many vehicles that were damaged during the 2017 hurricane season. Since then, monthly vehicle sales have barely been above a 17 million annual rate.
Manufacturing was strong for most of 2018. But as I’ve documented in these weekly reports, the rate of growth started to slow in recent months and is well below the peak.
Falling energy prices are one cause of the change in manufacturing. In addition, trade conflicts hurt manufacturing exports. Higher interest rates and concerns about growth have kept companies from investing in equipment, especially technology, and that hurts manufacturers.
Stocks had a turbulent year. Volatility rose from its unusually low levels in 2016 and 2017. Recently, volatility has been higher than it has been in several years.
The major U.S. indexes began the year by continuing 2017’s surge and reached record highs. But there was a sharp collapse in early February, and the indexes didn’t find a floor until early May. After that, stocks marched steadily higher and set new records in August and September.
But stocks peaked in late September and began the decline that continued for the rest of 2018.
So, the year that began with U.S. stock indexes setting a series of record highs ended with investors wondering how low stock prices will go.
International stocks peaked before U.S. stocks. Most international markets surged ahead of the U.S. markets in 2016 and the first part of 2017. But European markets peaked in 2017 and didn’t recover.
Bond volatility also increased during 2018.
Long-term treasury bonds declined steadily in January and early February as interest rates rose. Then they were in a trading range until late August. Bonds declined steadily with stocks until early November.
Since early November, long-term treasuries have been climbing higher. Often this is an indication that the economy is slowing and might be headed toward a recession.
The causes of 2018’s market and economic volatility aren’t secrets.
The primary reason is reduced global liquidity as the Fed and other central banks tightened monetary policy. The well-publicized trade conflicts also increase volatility, reduce economic growth and dampen stock prices.
Political uncertainty unsettles investors. There is political turmoil throughout Europe, as well as in the United States. Of course, geopolitical tensions between the world’s major countries unsettle markets from time to time and threaten economic growth.
Central banks and their monetary policies remain the dominant forces for the economy and markets. While investors have a lot to worry about, money and credit have durable effects. With central banks tightening policy, it looks like economic growth will continue to slow in 2019 and that likely means lower stock prices and perhaps higher bond prices.
The Data
Durable Goods Orders had a nice 0.8% increase for the month. That’s a big improvement from last month’s 4.3% decline. But the wide changes were due mostly to changes in the volatile aircraft sector. Excluding transportation, orders declined 0.3%. More importantly, core capital goods declined by 0.6%. That’s the main indicator of business investment in plants and equipment. But last month’s core capital goods figure was revised higher from no change to a 0.5% increase.
Consistent with that, the Kansas City Fed Manufacturing Index declined to 3, following a 15-reading for the index last month. The 3 is the lowest reading in more than two years. Most components of the report were weak.
The Richmond Fed Manufacturing Index took an even bigger tumble. It was reported at negative 8, down from 14 last month. That negative reading was far below expectations. Shipments plummeted to their lowest level since April 2009, and new orders also sank. Most components of the report showed significant declines.
Personal Income increased only 0.2%, following a 0.5% increase last month. But households were willing to dip into savings to spend. Consumer spending increased another 0.4%, following a 0.8% increase last month.
The PCE Price Index, the Fed’s preferred inflation measure, remained very low. It increased only 0.1% for the month, and the change was the same after excluding food and energy. Over 12 months, the headline index increased 1.8%, and after excluding food and energy the measure increased 1.9%.
Consumer Sentiment as measured by the University of Michigan increased to 98.3 from 97.5. That uptick in consumer sentiment reverses two months of declines. Once again, however, there was a wide gap between the current conditions component, which was very positive and increasing, and expectations, which were much lower and declining.
But Consumer Confidence, as measured by The Conference Board, declined to 128.1 from 135.7. That’s the least confidence since July. As with Consumer Sentiment, confidence in current conditions remains high while expectations are declining sharply, as are plans to make major purchases in the next six months.
Home prices had a surge recently, according to the S&P Corelogic Case-Shiller Home Price Index. It increased 0.4% for October, and September’s number was revised higher to 0.7% from 0.3%. Over 12 months, the index has increased 5.0%, compared to 5.2% in last month’s report.
The FHFA House Price Index showed a 0.3% monthly increase in prices with no revision to last month’s 0.2% increase. The 12-month increase is 5.7%, down from last month’s 6.1%.
New home sales data were scheduled to be released this week, but the release is delayed because of the federal government shutdown. A continuation of the shutdown will cause other data releases to be delayed.
The third estimate of gross domestic product (GDP) for the third quarter was mostly unchanged from the second estimate. The annualized rate of growth was down a bit to 3.4% from 3.5%. Real consumer spending also decreased a little to 3.5% from 3.6%. The GDP Price Index increased marginally to 1.8% from 1.7%.
New unemployment claims declined by 1,000 to 216,000.
The Markets
The S&P 500 fell 1.44% for the week ended with Wednesday’s close, even after yesterday’s record rally. The Dow Jones Industrial Average lost 1.75%. The Russell 2000 declined 1.54%. The All-Country World Index fell 0.95%. However, emerging market equities rose 1.12%.
Long-term treasuries lost 0.96% for the week. Investment-grade bonds decreased 0.74%, Treasury Inflation-Protected Securities (TIPS) fell 0.38% and high-yield bonds lost 0.45%.
On the currency front, the U.S. dollar fell 1.12%.
Energy-based commodities lost 1.38% for the week. Broader-based commodities fell 1.59%. Gold rose 1.93%.
Bob’s News & Updates
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I’m now a regular contributor to the Forbes.com blog. You can view my contributor page here.
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