The S&P 500 finished 2018 in negative territory for the first time since 2008, down -4.6% for the year. Volatility increased significantly across global markets as economic growth moderated and trade tensions rose. The CBOE Volatility Index increased 130% in 2018 compared to 78% in 2008, indicating a more turbulent decline. Investor unease over trade and monetary policy contributed to the rise in volatility, exemplified by an 8% market fall following the Federal Reserve's signal of slightly more aggressive rate hikes than expected in 2019.

1. After ending the third quarter of 2018 up over 10%, the
S&P 500 declined significantly in the last three months of
the year to finish in the red. Volatility is back, and
moderating global economic growth has caused unease
and fear that haven’t been felt in the markets since the
tantrum of early 2016.
Global Markets Performance
The US stock market, as represented by the S&P 500, finished down about -4.6% on the year, the first
negative calendar year return since the Global Financial Crisis (GFC). Smaller US stocks1
performed even
worse over the course of the year and fell more than their larger peers, by -11%. International stock
markets2
and emerging markets3
similarly dropped alongside domestic equity markets, with returns of
-14.2% and -14.6%, in part due to a strong US dollar. On the credit side, core intermediate bonds5
were
flat and high yield bonds6
returned about -2.3% for the quarter, impacted by lower rates but more than
offset by widening spreadsa
. Emerging market (EM) bonds7
fell in line as well with negative performance
of about -4.6% on the year.
© Morningstar 2018. All data as of 12/31/2018. All rights reserved. The information contained herein: (1) is proprietary to
Morningstar and/or its content providers; (2) may not be copied, adapted or distributed; and (3) is not warranted to be
accurate, complete or timely. Not all index performance mentioned is displayed above. See references for more detail.

2. The Guns of December
In our fourth quarter missive exactly one year ago, we mentioned the likelihood of volatility picking up in
2018 and the years beyond. As 2018 has now come to a close, it comes as no surprise to most that
volatility did indeed increase amidst the clamor of trade conflicts, Federal Reserve policy, and rising
interest rates. The CBOE Market Volatility Index (VIX), which measures the volatility of the S&P 500b
,
increased an astounding 130% in 2018. As a point of reference, the VIX rose by only 78% in 2008 during
the depths of the GFC.
So while the markets may have not fallen as hard as they did ten years ago, the manner in which they
fell this year has been much more turbulent. Part of this return to volatility can be attributed to a
regression to the mean, as 2017 witnessed a nearly unprecedented lack of such. But the remainder
must be credited to investor unease over both global trade concerns and monetary policy convergencec
.
A testament to the market’s fascination with monetary policy can be seen following the December
meeting of the Federal Reserve’s Federal Open Market Committee (FOMC), which sets monetary policy
for the central bank. The market fell nearly 8% in the four days following the meeting. The culprit? The
FOMC planned slightly more aggressive monetary policy for 2019 than was widely believedd
.
And this alludes to a central theme in markets that investors should appreciate – namely, that markets
are forward-looking and thus largely moved not by the current fundamentals but by expectations of the
future fundamentals. In other words, markets tend to move well in advance of any pickup or
deterioration in economic growth.
Source: Goldman Sachs Global Investment Research, Bloomberg8.

3. We Go Together…For Now
As the famous song from Grease goes, “we go together…that’s the way it should be.” But in markets
and across asset classes, that’s not the way it historically has been or academically should be. Modern
portfolio theorye
, one of the newer theories in financial academia, argues that diversifying one’s
investments across stocks, bonds, and other assets should create a portfolio of securities with offsetting
return and risk profiles. In other words, when stocks go up, bonds should go down, and vice versa.
This phenomenon is known as inverse correlationf
, and it has become the bedrock on which modern
investment theory has been built. From the early 1980s until 2016, the levels of interest rates in the US
had been on a steady decline. But in mid-2016, following the first rate hike by the Federal Reserve since
the GFC, interest rates broke that trend and began increasing.
What happens from here, should rates continue to move higher, is unproven ground in modern financial
theory. According to theory, rising rates would lead to depressed or negative fixed income returns, on
average, regardless of concurrent equity performance. And that is a frustrating prospect for investors
who have depended on a simple stock-bond portfolio for asset growth, income and stability.
However, it’s important to note that even with rising interest rates, the coupon income attached to
fixed income securities is generally sufficient to balance out that increaseg
. This should become more
evident if rates climb higher. Why? Because fixed income price returns are derived by the rate of
change of interest rates, while the coupons are derived by the level of rates. So as bonds are issued with
higher yields, the elevated coupon income can act as a stronger buffer to further price increases.
Historical 10 Year Treasury Rates
Source: Macrotrends9.
A Brief History Of Time And Cycles
For the past several years there have been countless market watchers calling for the end of the current
bull market. Some have cited its length, some elevated valuationsh
, and others have pointed to
troubling fiscal issues such as high debt levels. There are valid concerns in all of these arguments. But

4. accurately calling the end of a bull market is notoriously difficult, and long-term investors should avoid
trying to time the markets.
However, as professional investor Howard Marks so bluntly puts it, “we may never know where we’re
going, but we’d better have a good idea where we are…and act accordingly10
.” There are many sources
and data points that we can look at to figure out where we are, but two of the most intriguing are debt
levels and the yield curvei
.
Debt levels around the world are high. Households, corporations and governments around the world
have increased their debt since the Global Financial Crisis, and debt in just about every measure is
higher today than it was in 200711
. Increasing debt spurs growth in the short term, but it takes away
from future growth as higher savings will eventually be needed to repay that debt.
Turning to yields, the yield curve
graphs the level of interest rates by
maturity. In previous outlooks
we’ve mentioned the 10-2 yield
curve, which measures the
difference in yield between a 10-
year Treasury bond and 2-year
Treasury note. This curve continued
to flatten throughout 2018, which
has historically been a precursor for
recessions (see chart). Should the
curve continue to flatten or invert, it
may be time for investors to
reevaluate their allocations. When
or if that happens, however, is
something that we’ll have to wait
and see.
Source: Oppenheimer 2019 Outlook12.
Looking Forward
The coming year will likely present investors with an environment that echoes the drama of 2018.
Markets move in cycles, so while no two years will be exactly the same, they do trend. It’s crucial that
investors accept and understand that volatility in markets is normal, and should be expected given the
ever-increasing digitization of the financial world. As always, it’s impossible to predict what’s next, but
it’s essential to maintain a long-term focus, remain diversified, and consult your financial advisor for
questions regarding your financial goals.
Ryan Walsh, CFA® is an investment advisor representative of NWAM, LLC dba Northwest Asset Management and RIA Innovations, an SEC
registered investment advisor. This publication is in no way a solicitation or offer to sell securities or investment advisory services. Statistical
information, quotes, charts, references to articles or any other quoted statement or statements regarding market or other financial information
is obtained from sources which we believe reliable, but we do not warrant or guarantee the timeliness or accuracy of this information. All
domestic and international rights are reserved. No part of this newsletter including text, graphics, et al, may be reproduced or copied in any
format, electronic, print, et al, without written consent from Ryan Walsh, CFA® and RIA Innovations. Neither Ryan Walsh CFA®, nor RIA
Innovations provide legal or tax advice. Please be advised to consult your investment advisor, attorney or tax professional before making any
investment decisions.

5. References:
Smaller US stocks1
– as represented by the Russell 2000 TR Index
International stock markets2 – as represented by the MSCI All Country World ex-USA Index
Emerging markets3
– as represented by the MSCI Emerging Markets TR Index
US Dollar Index4 – as represented by the US Dollar Currency Index (DXY)
Core intermediate bonds5 – as represented by the Bloomberg Barclays US Aggregate Bond Index
High yield bonds6 – as represented by the ICE BofAML US High Yield Index
Emerging market bonds7 – as represented by JPM Emerging Market Bond (EMB) Global Index.
VIX Chart8 – sourced from “Index Volatility,” December 2018, Goldman Sachs.
Treasury Rate Chart9 – sourced from Macrotrends, “10-Year Treasury Bond Rate Yield Chart.”
Howard Marks Quote10
– sourced from “The Most Important Thing,” Howard Marks, page 125, 2016.
Debt Levels11
– sourced from Barron’s article, “A Top Money Manager Sees Rally Nearing Its End,” December 5 2018.
Oppenheimer 2019 Outlook12 – sourced from Oppenheimer 2019 Outlook, “U.S. Lands Softly, Converges with Rest of the World.”
Glossary:
Spreadsa
– the difference in bond yields of the same maturity but differing qualities, e.g. corporate bonds vs. US government bonds.
VIXb – the VIX measures the market’s expectation of 30-day look ahead volatility in the S&P 500 based on the price of options underlying the
index; derivatives, including options, are securities whose prices are derived from other securities and markets.
Global Monetary Policy Convergencec – refers to the phenomenon of global central banks following the same or similar monetary policy
processes, such as raising rates concurrently.
Monetary Policy For 2019d – the Federal Reserve announced its plans to raise interest rates twice in 2019, while the market expected 0-1 hikes.
Additionally, the FOMC planned to continue rolling securities off its balance sheet at the current pace, a move that investors had hoped would
be slowed and/or halted.
Modern Portfolio Theorye
– developed by Harry Markowtiz and first published in the 1950’s, MPT is based on the idea that portfolios can be
constructed utilizing the different risk, return, and correlation characteristics of separate asset classes. Much of modern finance is based on
this principle.
Inverse Correlationf – the property of moving in opposite directions. In investments, it refers to the returns of two assets moving in different
directions, dependent on the strength of the relationship.
Coupons And Ratesg – fixed income returns are derived in two ways: coupons and price appreciation. Coupons are the income paid as a
percentage of the principal value, and price appreciation is the change in price due to the change in rates since the issuance of the securities.
Elevated Valuationsh
– when the financial media and commentators refer to valuations in the markets, they generally refer the forward-looking
P/E ratio, which weighs the current price against the estimated next 12 month earnings of the S&P 500.
Yield Curvei – a graphical representation of the term structure of interest rates. It displays at each issued maturity level what the matching
interest rate is, and links all points to create a fluid curve.