— 2018 Q4 Update —

 

The fourth quarter of 2018 was marred by a phenomenon we have not seen much of during the last decade in the financial markets – high volatility and negative returns. These can be frightening times to have your retirement portfolio invested in equities if you do not know why these phenomena are happening. There are 3 main reasons the markets were acting up in the fourth quarter: rising interest rates, the U.S.-China Trade War, and the Federal Reserve unloading their balance sheet.

Interest rates affect every aspect of the financial markets, from lending practices to discount rates on equities. Therefore, when interest rates are changed by the Federal Reserve Bank (Fed), they change everything about how the markets operate. When inflation reaches a certain level in the economy the Fed will increase interest rates which will cause the economy to slow down. In the fourth quarter, short term interest rates were raised which hurt equities. The good news for investors is that inflation appears to be reaching a key point which might stop the Fed from increasing interest rates in 2019 at the same rate as they did in 2018.

We have been hearing about tariffs on the news for over a year now and while they may not feel like a big deal in your life, they can inadvertently affect your portfolio. Tariffs inherently make goods more expensive for consumers while protecting the domestic industries that make those same goods. Obviously, when items are more expensive, less of those items are purchased which causes profits to diminish. The U.S.-China trade war could hurt the financial markets for those exact reasons and if the trade war continues to become more intense, the financial markets will likely suffer as a direct consequence. Whether this will be a net benefit for the U.S. in the long term is a subjective question at this point in time, but it is a factor affecting the flow of money into the markets. 

Lastly, the Fed has a massive amount of assets on their balance sheet. Assets they bought to help save the markets during the financial crises of 2008. They are currently letting those assets unload off of their balance sheet and it is causing some uncertainty in the markets because this is unprecedented. Unprecedented events tend to increase volatility in the markets.

Overall, it was a rocky fourth quarter of 2018 but all hope is not lost.

We are probably coming towards the end of the longest bull market in U.S. history but we are most likely not looking at a situation similar to 2008. As long as the Fed continues to raise interest rates, the US-China trade war persists, and there is confusion about the effects the Fed’s unloading balance sheet will have, there will be volatility. The good news is that inflation seems to be reaching a point where the Fed has the incentive to slow down the rate hikes, the trade war could end at any point in time, and the Fed’s balance sheet might be a negligible factor in the markets.

As always with long-term investments, it is important to focus on your financial goals rather than getting caught up in short-term market changes. Working with a financial advisor to review your asset allocation during these times can help to avoid emotional responses to market volatility.

The Federal Reserve System (the Fed) is the central banking system of the United States and controls the Federal Funds Rate (aka Fed Rate), an important benchmark in financial markets used to influence the supply of money in the U.S. economy.  Inflation is the rise in the prices of goods and services, as happens when spending increases relative to the supply of goods on the market.  Moderate inflation is a common result of economic growth.