Q4 2018 What Just Happened
COMMENTARY FROM THE INVESTMENT COMMITTEE OF CORAL GABLES TRUST COMPANY
Q4 2018 - What Just Happened?
Volatility quickly emerged in the fourth quarter due to continued trade disputes, confusing Fed messaging and signs of a global slowdown. The S&P 500 returned -13.5% for the quarter and closed out the year with a -4.4% loss. The technology heavy NASDAQ, which fueled the market gains in the beginning of the year, abruptly declined in the fourth quarter with a loss of -16.84% and was lower by -0.29% in 2018. This contrasted greatly from last year with its 2017 annual return of 28.24%. On the economic front, employment data released for the quarter remained strong with the unemployment rate increasing by 0.2% but remained under 4.0%. Wage growth continued for the fourth quarter at a rate high enough to keep the Fed's attention. GDP growth for the third quarter was 3.4% and the fourth quarter is estimated to be slightly lower at 2.8%. Investors are bracing themselves for the upcoming fourth quarter earnings season and many hope results will be good enough to distract from the tariff war and Washington drama. Expectations for Q4 2018 earnings growth are 11-14% year over year, which is down from a 24% growth rate in the first half of 2018. The earnings growth expectation for 2019 is rather subdued between 6% to 9% due to tax reform disappearing.
In December, President Donald Trump and Chinese President, Xi Jinping, agreed to a ninety-day ceasefire to the trade war. If no deal is reached by March 2nd, President Trump said he will proceed in raising tariffs to 25 percent from 10 percent on the $200 billion worth of Chinese imports. We believe that a deal will be reached since these trade discussions are occurring at a time when China's economy is significantly declining in growth. Companies on both sides continue to feel the effects of tariffs while they remain in limbo until a deal is agreed upon. Overseas the MSCI EAFE index was down -13.79% and Emerging Markets was down -14.58% in 2018 which is reflective of these global trade pressures.
The Federal Reserve raised rates in December, as expected, bringing the Fed Funds range to 2.00% - 2.50%. The Federal Reserve is determined to achieve its "policy-neutral" federal funds rate of 3.00% which is indicative of two more interest rate increases. However, they did soften their tone in December indicating they will be data dependent going forward. The 10-year treasury ended the year at 2.69%, moving 29 basis points, or 0.29% higher, since 12/31/2017. The yield curve tightened further with the 2-year and 10-year yield difference at 21 basis points for the year. Investors will remain cautious as the Federal Reserve continues its path to normalization while watching for any kind of yield curve inversion. Foreign bonds were down last year while the Barclays Aggregate Bond Index closed the year with a slight gain at 0.01%. Short-duration fixed income was the best performing fixed income segment in traditional U.S. fixed income. The U.S. treasury Short Bond Index was up 1.89% in 2018. Assuming the Fed Funds Rate is at or near neutral, investors should look to increase duration slightly to lock in higher yields.
THOUGHTS ON ASSET ALLOCATION
Volatility in the fourth quarter quickly wiped out equity returns for 2018. The equity markets had been performing quite well until the start of their vast decline in October. Markets briskly de-risked from growth and favored the fundamentally strong value areas of the market. As we write, fourth quarter earnings season begins as investors watch closely for any clues pointing to a global slowdown. Guidance will be important which will shed light on the state of corporate America that is caught in the middle of a trade war and government shutdown. The Trust Investment Committee meeting in December provided an opportunity to review our manager performance in what was a very difficult market. The Committee elected to make a change in the large-cap value space by adding the Cullen High Dividend Value Fund in place of the Oakmark Fund. We held the Oakmark Fund for nearly five years with a successful track record during our holding period. Their performance in the fourth quarter, however, was shy of our expectations of downside protection and we took the opportunity to analyze them further. The Cullen High Dividend Value strategy will provide a lower beta and higher yield to our equity blend and has shown a long record of downside protection in turbulent markets.
We remain confident that we have selected superior managers in our equity and fixed income portfolios. With regards to the high volatility experienced in the fourth quarter, several of our managers beat their benchmark by significant margins. We continue to select active investment managers that can weather tough market conditions and protect capital in times of turbulence and geopolitical distress. Several of our managers outperformed on the year as indicated below:
Investment Manager / * 2018 Return / Manager Benchmark
T. Rowe Price MC Growth Fund / -1.73% / -4.75% Russell MC Growth
MFS International Discovery Fund /-10.66% / -17.78% MSCI Ex USA SC
T. Rowe Price Large Cap Growth / +4.32% / -1.51% Russell 1000 Growth
AMI Asset Management LC Growth / -0.52% / -1.51% Russell 1000 Growth
Cullen High Dividend Value / -3.30% / -8.30% Russell 1000 Value
Granite Small Cap Growth / +8.00% / -9.31% Russell 2000 Growth
*Returns are expressed as composite returns. Results may vary. Past performance is no guarantee of future returns
We look forward to speaking with all of you regarding our views and the performance of your respective portfolios. In addition, please ask about our financial planning capabilities. For additional information or questions please contact Mason Williams, Chief Investment Officer, at 786-497-1214.