December Doldrums

By Ketu Desai

“In the 20th century, the United States endured two world wars...the Depression, a dozen or so recessions and financial panics, oil shocks, a flu epidemic, and the resignation of a disgraced president. Yet the Dow rose from 66 to 11,497." – Warren Buffett, 10/17/08

The pain intensified for equity investors in December. This was the worst December performance for the market since the Great Depression. According to Oppenheimer, since 1945, we have had 13 sell-offs between 10-20 percent in the S&P, and the average time for recovery was eight months. The sell-off has as much to do with positioning, sentiment, liquidity, technicals, and flows as it does with fundamentals. In recent months, the economy and the markets have decoupled. While the domestic economy has cooled off, and there are pockets of weakness in housing and autos, the data still points to respectable growth. The latest estimate of fourth quarter GDP growth from the Atlanta Fed is 2.7 percent. The consumer, which is more than two-thirds of the economy, remains in good shape. Jobless claims are near historic lows, the savings rate has doubled since the crisis, and household debt service is near the lowest it's been since the data series came out. Retail sales have been robust, which have been driving growth estimates upward. The Conference Board Leading Economic Index indicates that growth should remain strong. The latest release at the end of December said that, “despite the recent volatility in stock prices, the strengths among the leading indicators have been widespread. Solid GDP growth at about 2.8 percent should continue in early 2019."

What changed significantly since the beginning of October has been positioning, sentiment, liquidity, flows, and technicals. Take for instance, the action in recent weeks. During the last week of November, Chairman Powell said that the Federal Reserve was “just" below its neutral rate, from “far away" in early October. As Chairman Powell changed his tune, speculators positioned for rising rates had to unwind those bets. During the first week of December, as they unwound, it caused a mild inversion in the mid-section of the yield curve, which caused investors to dump equities, led by bank shares. As they sold equities, technical levels were breached, which caused further selling. This all comes in a period when there are significant hedge fund and mutual fund redemptions, tax-loss selling and tighter liquidity due to monetary policy and seasonal factors, thus leaving a significant amount of selling with limited buyers. During second week of December, we had the largest on record weekly outflow from equity mutual funds. Sentiment has fully turned to near extreme bearish levels. Investors have rotated into utilities and bonds, positioning for an imminent recession.

Looking forward to 2019, global growth is expected to slow down, with most anticipating growth in the low to mid-3 percent range, from nearly 4 percent this year. Euro Area growth appears to be slowing, and is at risk of recession. Japan is expected to continue to grow around 1 percent. Chinese growth will also slow into the low-6 percent range. China has announced it will continue to increase stimulative measures to support their economy. India is expected to remain the fastest growing major economy, in the mid-7 percent range. Emerging markets had a challenging 2018. Most of their equity markets have fallen significantly, as have their currencies relative to the dollar. Emerging market equities led on the way down, however, have recently outperformed domestic equities; they could be leading on the way back up. Interestingly, Bitcoin also led on the way down, and has rallied recently. The S&P earnings grew by more than 20 percent in 2018, however, multiples contracted by a similar amount. Earnings will likely grow in the mid-single digits next year; however, the multiple investors are willing to pay will determine the return. Rates, inflation, and Fed policy will be critical to the multiple. In recent years, January has produced outsized moves both positive and negative; the market will have plenty to focus on this year from a Fed meeting, to earnings, and updates on China trade talks. It will be another eventful year!

Happy New Year!


Ketu Desai is the Principal of i-squared Wealth Management Inc. (, an investment management firm based in New Jersey.