Equity markets shrug off geopolitical tensions; experience strongest week since early March

Week in Review

Broad US equity markets experienced their strongest week since early March, pushing all major indices back into positive territory year-to-date. While there did not appear to be any major catalyst driving markets higher, investors seemed to be less deterred by geopolitical events than what has been experienced since the February correction.

On Tuesday afternoon, President Trump announced the decision to withdraw from the Iranian nuclear deal. Equity markets, which had been slightly positive earlier in the day, turned abruptly lower immediately following the news as the decision added another layer of geopolitical uncertainty to an already fickle market. Over the past few months, this type of news would have resulted in another pullback for broad stock markets.

However, stocks rallied to close Tuesday mostly flat, and continued higher through the remainder of the week. This behavior illustrates investors may be starting to focus more on the underlying fundamental factors in the markets rather than the political noise, which could lead to a more bullish posture after months of elevated volatility and consolidation.

With more than 90% of companies having reported quarterly earnings, results are on pace to be the strongest since Q3 2010. Furthermore, the labor market and other economic fundamental factors remain mostly strong for the moment, which points to the potential for continued economic growth. Nevertheless, data and market sentiment can change quickly, which is why it is important to include a broad range of asset classes in your portfolio for more consistent and more stable longer-term results.

As investors, we need to stay committed to our long-term financial goals. 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 finished the week positive as volatility subsided. As the Index moved higher, it cleanly broke through the resistance level that formed earlier in the year. Illustrated in the chart below, the Index has been consolidating in a triangle pattern in recent months, reaching lower highs and higher lows. Generally, with these triangle patterns, markets continue to consolidate until there is a fresh breakout. With the recent breakout above the upper trend line, it may indicate the start of a new bullish trend. However, it is important to remember these patterns do not work 100% of the time, which is why it important to include multiple factors when evaluating market health. The coming weeks should continue to provide valuable insight about the near-term direction of the S&P 500, but it seems to have shifted to a more bullish pattern after breaking through the resistance line.

*Chart created at StockCharts.com

 

Market Update

Equities

Broad equity markets finished the week positive as broad US stocks outperformed international stocks. S&P 500 sectors were mostly positive with cyclical sectors outperforming defensive sectors.

So far in 2018 technology, consumer discretionary, and energy are the strongest performers while consumer staples, telecommunications, and real estate have been the worst performing sectors.

Commodities

Commodities were positive as oil prices rose 1.41%. Crude oil prices reached $70/bbl for the first time since November 2014 as renewed US sanctions on Iran tightened the outlook for global supply. Supply and demand has been somewhat balanced in recent months due to the continued OPEC production cuts.

Gold prices were positive with a 0.48% gain as the dollar index fell slightly. Despite a stronger dollar in recent months, gold remains relatively flat for the year due to continued geopolitical concerns. A stronger dollar typically makes dollar-denominated assets, such as gold, more expensive for holders of other currencies, pushing prices lower.

Bonds

The 10-year treasury yield increased slightly from 2.95% to 2.97%, resulting in flat to slightly negative performance for traditional US bond asset classes. While yields remain near the 3% threshold, weaker than expected inflation data eased concerns about the pace of Fed rate hikes in the near-term.

High-yield bonds were positive as risker asset classes performed well during the week. As long as the economy remains healthy, higher-yielding bonds are expected to continue outperforming traditional bonds in the long-run as the risk of default is moderately low.

Asset class indices are mixed so far in 2018, with commodities leading the way and traditional bond categories lagging behind.

 

Lesson to be learned

The investor’s chief problem – and even his worst enemy – is likely to be himself.”

– Benjamin Graham

People are emotional, and possess many biases when it comes to investing. A couple examples of these biases include hindsight (looking back and thinking it was easy to predict how things actually played out) and illusion of control (the tendency for people to overestimate their ability to control events they cannot actually influence). Unfortunately, these biases make us more susceptible to short-term market noise and poor investment decision making. This is why it is important to maintain a disciplined, emotion-free, investment strategy.

 

FFI Indicators

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 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 22.56, forecasting further economic growth and not warning of a recession at this time. The Bull/Bear indicator is currently 50% bullish – 50% bearish. This means the indicator has a neutral outlook on stock market direction in the near term (within the next 18 months).

 

The Week Ahead

With the S&P 500 breaking out of its recent triangle pattern, it will be important to see how markets move in the upcoming week. Has shorter-term momentum shifted to a more positive posture, or will other factors prevent markets from moving higher?

 

More to come soon.  Stay tuned.

Regards,

Derek Prusa, CFA, CFP®
Senior Market Analyst

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Derek Prusa, CFA, CFP®
Senior Market Analyst

Derek works closely with Jason Wenk to research and monitor financial market conditions and select the best investment strategies for each of our proprietary models.

Derek graduated Summa Cum Laude from Ferris State University with a bachelor’s degree in Investment Finance. He was ranked #1 in the School of Business and received the Delta Sigma Pi Scholarship Key for his academic accomplishments. In 2015, he was named in LifeHealthPro’s 30 under 30.