Following the best four-month start to a year for US stocks since 1999, markets retreated as renewed tariff fears took center stage. In recent weeks, many major indices had reached fresh all-time-highs as it appeared the US and China were closing in on a trade deal. However, early in the week US officials accused China of backtracking on language that had previously been negotiated. This led the Trump administration to increase tariffs on $200 billion in Chinese goods from 10% to 25%.
It was the worst week for the S&P 500 so far this year as the disappointing trade news caused investors to seek safety. For the second time this year, the treasury yield curve experienced a partial inversion – this time the 10-year yield dropped below the six-month yield. While these specific yield curve points are not as widely followed as some others (such as the 2-year and 10-year relationship), instances of shorter-term bonds yielding more than longer-term bonds are historically rare and have often preceded recessions.
Despite the pullback, the S&P 500 is still more than 22.5% higher than its recent December low. This past week is a reminder of just how fickle markets can be at times. While stocks have rallied significantly in recent months, there are still many reasons to remain cautious including slowing global growth, ongoing trade uncertainties, and a tight yield curve.
Weekly market movements and flashy news headlines can make it tempting to make knee-jerk decisions, but as investors we need to stay committed to our long-term financial goals and risk tolerance. Staying focused on our long-term investment objectives and maintaining a disciplined investment strategy can help reduce market noise and increase the odds of a successful outcome over time.
Chart of the Week
The S&P 500 had its worst weekly session since the week before Christmas as volatility returned to markets. President Trump implementing additional tariffs on Chinese goods coupled with a failed trade negotiation had some investors turning bearish. However, the drop in the Index should be taken with a grain of salt, as in March we experienced a decline of 2.16% swiftly followed by a gain of 2.89% — the best week since Christmas.
*Chart source: Bloomberg
Broad equity markets finished the week negative as large-cap stocks fared better than small-cap stocks. S&P 500 sectors were also negative, with defensive sectors outperforming cyclical sectors.
So far in 2019, technology and consumer discretionary are the strongest performers while healthcare has been the worst performing sector.
Commodities were negative as oil prices decreased by 0.45% to $61.66/bl. This is the third consecutive weekly decline since President Trump announced Iranian sanction waivers will not be renewed. During the week, the United States’ decision to increase tariffs on Chinese goods contributed to fears about slowing global growth. However, the possibility of resuming negotiations remains a beacon of hope to market participants. Oil prices were at least somewhat supported by tight supply levels led by OPEC production cuts and sanctions.
Gold prices increased by 0.50%, closing the week at $1,286.70/oz. Gold, as a US dollar-denominated safe-haven asset class, tends to rise when the market experiences abnormal volatility. Currently, markets are being shaken by returning geopolitical tensions. Additionally, investors remain conflicted about their choice of asset class going forward as high US stock price-to-earnings multiples make companies appear slightly overvalued. On the other hand, US treasury yields remain low offering an unattractive alternative. Going into the remainder of 2019, gold has the potential to rise if tensions remain and the market direction remains uncertain.
The 10-year Treasury yield decreased from 2.54% to 2.47%, resulting in positive performance for traditional US bond asset classes. During the week, yields slipped as the US increased its tariff rate on certain Chinese goods to 25%. Additionally, the spread between the 6-month and 10-year yield inverted — slightly rattling global markets. As we continue into the year, rising geopolitical tensions have the ability to push yield lowers.
High-yield bonds were negative for the week as riskier asset classes fell and credit spreads loosened. However, as long as US economic fundamentals remain healthy, higher-yielding bonds have the potential to experience further gains in the long-run as the risk of default is still moderately low.
Asset class indices are positive so far in 2019, with small-cap US stocks leading the way and traditional US bonds lagging behind.
Lesson to be Learned
Many people watch the prices of stocks they have recently sold more closely than the prices of those they still own; thus they show themselves to be more concerned with justifying past actions than in planning future ones”
– John Brooks
Hindsight bias leads us to believe an event was more predictable than it actually was. Unfortunately, this is an easy trap for many investors to fall into, reliving how they would have “acted differently” now knowing the circumstances of today. We need to be careful when evaluating how past events actually impact current market conditions. The past cannot be changed, but we still have the ability to adhere to a smart investment strategy and make our portfolio better in the future. Removing emotions from the investment process can help us avoid biases like hindsight, keeping us focused on what really matters – our plan moving forward.
FormulaFolios has two simple indicators we share that help you see how the economy is doing (we call this the Recession Probability Index, or RPI), as well as if the US Stock Market is strong (bull) or weak (bear).
In a nutshell, we want the RPI to be low on the scale of 1 to 100. For the US Equity Bull/Bear indicator, we want it to read least 66.67% bullish. When those two things occur, our research shows market performance is strongest and least volatile.
The Recession Probability Index (RPI) has a current reading of 29.29, forecasting further economic growth and not warning of a recession at this time. The Bull/Bear indicator is currently 66.67% bullish – 33.33% bearish, meaning the indicator shows there is a slightly higher than average likelihood of stock market increases in the near term (within the next 18 months).
The Week Ahead
With earnings season winding down, investors will be closely watching how the most recent escalation in the trade dispute between the US and China plays out.
More to come soon. Stay tuned.
Derek Prusa, CFA, CFP®
Senior Market Analyst