December 2018 will go down in history as the time when one of the longest bull markets in U.S. history ended. While we’ve had significant corrections in 2011 and 2015, the bull run starting in 2009 didn’t officially end until December, when a rout resulted in 20% losses for the S&P 500, Nasdaq 100, and Dow Jones Industrial Average.
The significance of the bear market in December goes further: the statistically anomalous nature of this trend.
Since 1950, 26% of Decembers were down, while 51 of those years were up. But even more peculiar, the 9.1% decline in the S&P 500 during the month is the second steepest December decline for the market ever, causing consternation and panic among investors.
The consternation has to do with the disconnect between equity prices and fundamental trends. Earnings look like they will be ending the year up about 20% from 2017, and the deceleration in earnings growth predicted in the first quarter ended up being significantly better than expectations. Yet 2018 was not only a tumultuous year for equities, but a down year.
For many investors, the blame is being put squarely on the trade war with China and the nearly inverted yield curve, with the majority of Wall Street analysts focusing on the yield curve rather than the China issues. A near widespread consensus is that the yield curve is almost solely to blame, and that the market is desperately trying to telegraph to the Federal Reserve that further rate hikes will result in another recession.
In this sense, 2018’s December decline resembles another recent decline. In 2015, stocks fell by 1.9% as the market reacted with panic to the Federal Reserve finally raising interest rates for the first time since the Great Recession, after expectations of a rate hike going back to 2009. But 2018’s far steeper loss indicates a greater sense of panic.
And it almost meets the worst December of all time: 2002, back when short-term interest rates had actually fallen to a near low, and several years before rates would increase in the mid-2000’s.
The severity of 2018’s price declines and the rationale behind it are anomalous, leading one to wonder if there isn’t a feedback loop of panic that a bear market is inevitable resulting in the bear market it is so afraid of. This is the market “reflexivity” concept made famous by George Soros, who argued that this feedback of perceptions of reality influencing reality itself is a key to understanding how markets function and how price discovery occurs over time.
Does this mean the market will overcompensate for its panic and result in markets recovering in 2019? There is no way to know—but the data does indicate that the recession investors have feared for years is nowhere near us. But since recessions can appear within a few months of good data, analysts will need to keep a careful eye to both the macro indicators and fundamentals in individual sectors to determine whether the recent market pain is set to continue.