Employment stayed high and inflation stayed low, but we all know that this can’t go on forever. Increasing concern about global economic trends contributed to the downbeat tone in U.S. markets.

Probably the most concerning event, however, came from the Federal Reserve, which continued their message about increasing rates through 2019. Not that the message was surprising, but the market needs to adjust when monetary incentives, like artificially low interest rates, are taken away. The Fed changed its tone a little during Q4, and stocks hung on every word (more about this under Bonds). The short-term effects from the fiscal stimulus of 2017’s tax cuts are also lessening.

There was a shift in the market as the it began to anticipate a slowdown. That shift was from growth stocks to value stocks. While both were down for the quarter, value was down considerably less primarily because value stocks hadn’t risen as far. Also, the stocks of smaller companies fell more than the stocks of large companies in Q4. Some refer to this phenomenon as “risk off” meaning that investors are concerned enough about the future that they want to lessen their more speculative investments, like highly-valued growth stocks and stocks of smaller companies.

Is our future all doom and gloom? No, in fact there are a number of reasons that the stock market could recover nicely in 2019. They include:

The possibility that the U.S. and China will finalize a trade deal. China needs us to buy their goods more than we need them and a deal will eventually come to pass. Note that China’s trade surplus with us hit a record $34 billion in September.
The price of oil has dropped again, falling from about $74 per barrel to under $50 per barrel in Q4. Since most of us are dependent on oil for many of our goods and services, a drop in price should lead to lower prices for consumers and higher profits for companies.
Inflation is still low, and there is little reason to believe that it will spiral out of control any time soon. The Federal Reserve continues to withdraw monetary stimulus through higher interest rates and reducing the amount of bonds it holds on its balance sheet. What this means is that when the economy slows, the Fed will have tools it can easily use to hopefully reduce the depth of the slowdown without triggering excessive inflation.
Finally, as we’ve been saying for quite a while, employment remains strong with the unemployment at only 3.7%. According to the Labor Department, available jobs in the U.S. last summer outnumbered workers by 902,000, the largest gap in 17 years.

In summary, the decline in the U.S. stock market in Q4 was not unexpected because we knew that eventually the market’s high valuations would begin to flag. Those valuations are now closer to most historic averages. With a still strong economy and rising corporate earnings, the U.S. market should eventually resume an upward trend.