Market Commentary: 4Q 2018

In a complete reversal from 2017, 2018 saw the bull market in US large cap stocks almost come to a halt amid a return to volatility.

Equities set several records during the fourth quarter, and none of those records were good. Global equities, real estate, and commodities were all negative for 2018; the last time this happened was in 2008. December 2018 was one of the worst Decembers for US equities since the 1930s. Also, US small cap stocks officially ended its almost 10?year bull market in December 2018 by declining more than 20% from its August peak. The main thing that 2017 and 2018 have in common is that most asset classes moved in one direction—a pattern that’s not seen in a typical year. In 2017, markets seemed to overlook the looming economic challenges. But markets finally reflected those challenges in their prices in 2018. While we don’t like the downturn, we are not alarmed by it. 

Investing in foreign developed and emerging market stocks appears wise, despite their underperformance in 2018. Conflict with our international trading partners continued to be a big factor in foreign stock underperformance this year. Also, global central banks have begun mirroring the US Federal Reserve policy of tighter money conditions. Both have weighed on equity prices across the globe. However, foreign developed and emerging market stocks held up better than US stocks during the fourth quarter. Additionally, after the dollar’s strong performance the past several years, the inflated U.S. budget deficit and the overvaluation we see in U.S. stocks, we believe the U.S. dollar is a risk factor that investors would be wise to avoid. Our allocation to foreign stocks provides our portfolios with protection and diversification away from the U.S. dollar. 

Here are the broad index returns through the Fourth Quarter of 2018*:

U.S. Large Cap Stocks -4.4% U.S. Aggregate Bonds 0.0% Global Real Estate -4.8%
U.S. Small Cap Stocks -11.0% International Bonds -0.8% Allocation 30%-50% Equity -5.0%
Overseas Stocks -13.8% Commodities -11.3% Allocation 50%-70% Equity -5.8%
Emerging Market Stocks -14.6% U.S. Real Estate  -5.8% Allocation 70%-85% Equity -7.9%

Economic Outlook

Many analysts are forecasting lower US GDP growth for 2019. The US economy is in the late stage of its expansion, ahead of Europe, the UK, and Japan, who are still in the middle stage of their expansions.  Additionally, going forward, US corporate earnings will not have the bump from tax cuts as they did in 2018. However, one wildcard continues to be the Federal Reserve’s campaign of rising interest rates. Recent indications from Fed officials, including Chairman Jerome Powell, suggest that the Fed is now more flexible regarding future rate increases and could even take a pause if economic conditions warrant. Inflation is projected to remain tame and unemployment is expected to remain low. It truly is a mixed-bag regarding the US economy in 2019.

Headlines are now turning from the US to Overseas. Brexit (the withdrawal of the United Kingdom from the European Union on March 29th) has been getting much press lately. The worst-case scenario would be that the UK leaves the EU without the necessary treaties and agreements in place and the British start to experience economic hardships like higher inflation and unemployment. Although UK stocks only comprise about 1-3% of our portfolios, we will continue to monitor the situation and adjust, if necessary. Another headline that keeps popping up is the projected slowdown in global growth beginning in 2019. However, the most current forecasts by both the World Bank and The Conference Board predict a drop in World GDP of only 0.2% over the next two years; clearly not the earth-shattering decline the media trumpets. Despite the risks we see over the short term, we have high conviction that our investments in European and emerging-market stocks will earn significantly higher returns than U.S. stocks over the next five to 10 years.

Over the next year, the range of potential equity market outcomes is just as wide as it was going into 2018. Our approach and preparation remain the same. We construct and manage portfolios to meet our clients’ longer-term return goals, which means successfully investing through multiple market cycles, not just the next 12 months.

Tax Planning – 5 Strategies for 2019

The first quarter is the time to begin tax planning for the year. Here are five things to remember for your 2018 tax return and to lower your taxes in 2019:

  1. If you are over 70 ½ years old and taking minimum required distributions from your IRA, consider a qualified charitable distribution (QCD) for your charity and church giving. When you use the QCD to give your gifts you lower your adjusted gross income. If you performed a QCD in 2018, remember to remind your tax preparer that the contribution is NOT tax-deductible.  
  2. Prior to the changes introduced by the new tax law, allowable itemized deductions were subject to phase-out for taxpayers whose income exceeded certain thresholds. The new tax law abolishes this limitation on itemized deductions for tax years 2018-2025. This makes giving during years of high income even more powerful.
  3. Starting in 2018, tax-free distributions from 529 plans can also be used to pay up to $10,000 of expenses per student per year for elementary and secondary schools. Alabama also provides a state income tax deduction for contributions to the state plan of up to $10,000.
  4. It may be time for you to update your will. Because the tax laws significantly increased the amount that can be passed tax-free to your heirs, the provisions in your will may no longer apply. Check with your estate planning attorney to see if it makes sense for you to have an update.
  5. Decide if this is the year to “bunch” your deductions. Remember that the standard deduction for couples will be $24,400 this year. In order to maximize the benefits of the higher deduction, alternate years of giving and deductible expenses to exceed the standard deduction every other year. 

We truly appreciate the opportunity to work with you and look forward to talking with you again soon!

*U.S. Large Cap=S&P 500, U.S. Small Cap=Russell 2000, Overseas Stocks=MSCI EAFE, Emerging Market Stocks=MSCI Emerging Markets, U.S. Bonds=Barclays Aggregate Bond Index, International Bonds=FTSE WGBI, Commodities=Bloomberg Commodity, US Real Estate=MSCI US REIT, Global Real Estate=S&P Global REIT: Data Source: Morningstar®. Economic Data: Litman Gregory Analytics and Vanguard Investments. Allocations=Morningstar® U.S. Fund Allocation Categories: Data Source: Morningstar®. Tax Planning Data Source: KPMG 2019 Tax Planning Guide. Index returns are for illustrative purposes only and do not represent actual performance of any investment. Client returns will differ from the results shown. Index performance returns do not include any management fees, transaction costs or expenses. The performance data quoted represents past performance and does not guarantee future results. The investment return and principal value of an investment will fluctuate; thus an investor’s shares, when redeemed, may be worth more or less than their original cost. Current performance may be lower or higher than return data quoted herein. Indexes are unmanaged and one cannot invest directly in an index. Please review your allocation regularly and notify BFA immediately if your circumstances should change.