U.S. stocks closed out the year with their worst December performance in history. The S&P 500 almost hit bear market territory on Christmas Eve (defined as a 20 percent or greater decline at close from the peak day’s close). Despite the rebound, stock indexes still posted the worst monthly, quarterly and annual returns seen since the Great Financial Crisis. Every major stock index—across market cap and style, domestic and international—has a negative return for 2018. Fixed income had a difficult year as well, despite relative strong performance during December and the fourth quarter in general. The BBgBarc US Aggregate Bond Index finished the fourth quarter positive by 1.64 percent, but due to pressures from rising interest rates during the first three quarters the index finished 2018 positive by only 0.01 percent.

The stock market was already on edge coming into December. The same risks that investors had sanguinely absorbed all year without much concern—Fed hiking rates too fast, uncertainty around trade negotiations and Trump in general, and the possibility of slowing economic growth—suddenly began to affect markets in the fourth quarter. The mood on these topics appears to have gone extremely pessimistic once December rolled around, especially after Fed Chair Jerome Powell’s December 19 press conference in which he announced an additional 25 basis point hike in the Fed Funds Rate. The hike was expected, but what spooked markets was his comment about the Fed’s plan to continue unwinding the balance sheet from its quantitative easing program at the current pace. Apparently this was more hawkish and inflexible than markets could handle, and stock indexes promptly declined. Over the course of the next several days, matters were not helped by a) headlines about Trump’s desire to fire Powell, b) Trump’s intransigence over getting funding for the border wall and thus causing a government shutdown and c) Treasury Secretary, Steve Mnuchin, making a bizarre attempt at reassuring investors that there was enough liquidity at the nation’s largest banks. Mnuchin’s action, which backfired and arguably caused the S&P 500’s Christmas Eve near-miss of a bear market, has been likened to a doctor reassuring a patient that they don’t have cancer when they only consulted the doctor about a runny nose. We also suspect that the volatility in the market was exacerbated by year-end tax planning. In addition to tax loss harvesting, many investors were selling mutual funds to avoid capital gain distributions. A record $56.2 billion flowed out of mutual funds during the week ending December 19, and while the risk-off environment was undoubtedly a factor, it’s likely that these other considerations played a role, too.

We have addressed the pain points that led to where we are, so let’s consider the outlook for each topic. Regarding interest rates, expectations for multiple Fed hikes in 2019 have all but evaporated. The probabilities provided by the CME FedWatch Tool are illuminating. At the end of November there was a 68.6 percent chance that there would be one or more rate hikes in 2019. Now, there is just a 10.5 percent chance of one hike and zero percent given to the probability of more than one hike. In fact, the FedWatch Tool places the probability of the Fed lowering the Fed Funds Rate in 2019 at as much as one in four. Of course these probabilities are subject to change, but market returns are based off of expectations, and expectations are for the Fed to ease off the rate hikes.

The second pain point has been the uncertainty that Trump brings. Whether you like Trump or not, most can agree he is unpredictable and doesn’t mind creating and exploiting chaos. As concerned as Trump may be about the stock market decline, we should not expect this to change his nature. Our impression is that his behavior will grow more volatile, and that if things continue to sour he will continue to blame the Fed as well as the Democrats as they take control of the House in January. While this is frustrating from an investor’s perspective, recall that markets had no trouble shrugging off much of the White House drama through 2017 and for most of 2018. It’s when other crises are emergent that Trump’s style tends to add fuel to the fire.

The third main concern of investors is that of slowing economic growth, both at home and abroad. While it’s true that it will be tough for 2019 to top 2018, both in terms of economic fundamentals and corporate earnings, the view among most economists is that 2019 will still be a good year. The consensus expectation is for a recession sometime in 2020, and a mild recession at that. GDP growth, the labor markets and corporate earnings should continue to trend positively in 2019.

The question is how markets will respond. Just as it’s possible for irrational exuberance to take hold, so it is the case with irrational pessimism. But surely as bubbles eventually pop, fear-based narratives must eventually ease up as well. There is only so much dissonance that can exist between the economic reality on the ground and how the markets behave.

As we look ahead to 2019, investors should begin to prepare themselves for disappointing 2018 returns. While the losses experienced in 2018 aren’t terrible when considered against other years in recent decades, they certainly represent a departure from the profitable last nine years. Many investors have grown conditioned to consider a “bad year” to be one in which the S&P 500 doesn’t achieve double digit positive returns. This bias is forgivable, but it’s important to not let it cloud your understanding of general investment principles and lead you to make a rash decision. If an investment portfolio was well thought out before stocks declined, then you should stick with it. If investors wish to enjoy the long-term appreciation of their stock investments, it is important that they not panic during periods of losses and take the bad days with the good.

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