As the fourth quarter opened, despite the turmoil roiling international markets, domestic stocks were enjoying healthy gains and seemed on their way to a tenth straight positive year. In the next three months, we witnessed a quarterly decline worse than any seen since the depths of the Great Recession; it wiped out gains and turned annual returns decidedly negative. Money streamed out of equities and into cash and bonds, causing waterfall declines due to an imbalance of buyers and sellers. Growth stocks, which had handily and persistently outpaced their value peers, were hit particularly hard in the quarter. The risk off tone pervaded further down the capitalization scale, with small cap stocks posting a quarterly decline of over 20%. International stocks continued to pile on their losses from earlier in the year. Emerging markets were hammered by falling commodity prices and the higher US dollar. Developed international was confronted by slowing growth and the continued economic and political uncertainty throughout Europe.
The weakness of the first quarter, when the S&P 500 closed lower in February and March, has become a distant memory. Building on the momentum coming out of the second quarter, the S&P 500 hit a new closing high on August 24th, surpassing the one set on January 26th. The rally in large cap stocks continued unabated through September, a month that has registered positive returns in only a third of the years since the 1960’s. Small cap stocks were unable to escape the September doldrums and, after pacing their large cap peers for much of the year, wound up lagging badly in the quarter. Like the second quarter, both growth and value stocks “worked” as they moved higher together, though growth continued to widen the performance gap compared to value. Dollar strength, slowing growth and trade related fears all conspired to hold down international indices: developed international returns were muted, and emerging markets were outright negative once again. China, down over 24%, sank firmly into the grip of a bear market. The continuing performance divergence between small caps and emerging markets has reached nearly historic proportions.