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If the final quarter of 2018 is any indicator of what’s ahead for investors, 2019 will be a wild ride. Exchange-traded funds linked to U.S. stocks slid into bear market territory, while volatility soared. What happened to the once reliable bull market?
Legendary investor Sir John Templeton once quipped, “Bull markets are born on pessimism, grown on skepticism, mature on optimism and die on euphoria.” During the fourth quarter, the euphoria that remained in stock prices was zapped by ongoing international trade wars, rising interest rates and political upheaval. Moreover, the fast decline in stocks is a sober reminder of how quickly the mood can change.
Whenever the S&P 500 has suffered declines of 10% or more in a single quarter, it has rebounded strongly in subsequent quarters. Going back to World War II, stocks had positive performance 73.7% of the time with an average gain of 15.94% during the next year, according to the Bespoke Investment Group. Just three years—1973, 2001 and 2002—saw negative returns during the next year.
Although most industry sectors slumped from their 2018 peaks, the performance during the full year was positive for health care and utilities. Among the two S&P 500 consumer sectors, the offensive-oriented Consumer Discretionary Select Sector SPDR Fund (XLY) posted a gain of 1.6% for the year while the defensive-minded Consumer Staples Select Sector SPDR Fund (XLP) posted an 8% loss.
Corporate earnings are still growing, but at a slower rate. Growth estimates in fourth-quarter earnings for S&P 500 companies had slightly decelerated from 14% to 12%, according to FactSet. Likewise, growth estimates for this year’s first quarter earnings have declined from 5% growth expectations to 3.5%, and to 4.2% for the second quarter.
Diversified commodity ETFs like the United States Commodity Index Fund (USCI) have been hampered by the collapse in crude oil and gasoline prices. While falling fuel prices are great for consumers, the Nuveen Energy MLP Total Return Fund (JMF) was clobbered with bear market losses exceeding 22%. But there’s a silver lining. Precious metals and natural gas have been relative outperformers within the overall commodities group. Moreover, gold and silver-focused ETFs have perked up during the stock market’s slide.
Investment-grade bond ETFs have been a safe haven, and funds such as the Vanguard Total Bond Market ETF (BND) performed steadily while delivering annual yield income between 2.75% and 3%. Meanwhile, junk bond funds like the SPDR Bloomberg Barclays High Yield Bond ETF (JNK) sold off on concerns about deteriorating credit quality and conditions.
The number of new ETFs is growing, but at a slower pace. Nevertheless, there was a pickup in funds tracking alternative asset classes, along with non-index linked funds.
Looking ahead, defensive strategies may play a more prominent role in advisor-managed portfolios as investors seek to mute stock market volatility and protect capital while remaining focused on their long-term goals. That could mean increased attention on ETFs with steady dividends, lower volatility and even funds that deliver inverse market performance. If market conditions continue to stumble in 2019, ETFs will continue to deliver a reliable punch of trading flexibility, hedging capabilities and growth opportunities. Fasten your seat belts!