The massive volatility experienced by most markets into the end of the year was truly atypical. In fact, it marked the worst December in approximately 50 years, a seasonal period that is usually favorable for investors.
A combination of low liquidity, algos, erratic policy negotiations and lofty valuations proved too poisonous of a cocktail for risky assets. Naturally, the question is what this action means going forward. Are risky assets now better priced and on the verge of a rebound or is this the beginning of the end?
From a short-term perspective, stocks went from expensive to somewhat inexpensive while bonds are still very expensive. Unfortunately, whether stocks are really inexpensive or not is not only a function of current prices but also of future earnings. Investors are still confused on what 2019 EPS may look like given such an erratic policy background especially when looking at the US-China trade war.
The good news is that traditional pre-recession indicators are not flashing high risk yet and the Fed seems to be cognizant of how quickly financial conditions have deteriorated and therefore it seems willing to show some flexibility in their tightening path.
So, while the short view is murky, how does the long view look like? Interestingly, while we just closed on one very strong decade, the nominal 20-year CAGR (compounded rate of growth) ended in 2018 is the worst since the Great Depression at an annualized rate of 5.52% (Source: Barron’s). The high volatility of the last twenty years with the 2000-2002 crash and the 2008 debacle have really taken a bite out of the long-term averages.
If mean reversion kicks in, that may be good news for the long-term investor; indeed, the 20-year market CAGR since 1928 is 10.7%, practically double what we just experienced.