Fed hikes rates for third time in 2018

Week in Review

Despite declining for the week as the Fed hiked interest rates, the S&P 500 Index posted its strongest quarter since 2013.

As expected, the Federal Reserve announced its third rate hike of the year, increasing the federal funds rate by a quarter of a percent to a range of 2.00% – 2.25%. Fed Chairman Jerome Powell stated the economy remains strong and rates remain relatively low, leading the Federal Open Market Committee to believe a continued gradual return to “normal” interest rates remains appropriate. In the latest projections, Fed officials estimated GDP to rise 3.1% in 2018 (up from 2.8% estimated back in June), and 2.5% in 2019.

Expectations for a fourth rate hike in December were also raised as a majority of Fed policymakers are now in favor of such a move (following the rate hike in June, policymakers were more evenly split between three and four rate hikes for 2018). Beyond this year, the Fed expects three more rate hikes in 2019, and one more in 2020. However, while the Fed shows no signs of taking a break in the current path of raising rates, broad interest rates moved lower following the decision as the word “accommodative” was removed from its description of monetary policy. Many investors took this to mean the Fed was getting close to the end of its current cycle of hiking rates, but Powell said this does not signal any change in the likely path of rates moving forward and simply illustrates rates are more normal than they were three years ago.

Strong earnings and economic data have continued to support US stock markets despite the ongoing geopolitical risks experienced so far this year. The S&P 500 experienced a total return of 7.71% in Q3, its strongest quarter since the end of 2013. Helping boost US stock market growth, GDP grew 4.2% in the most recent quarter – its fastest pace of growth in four years.

However, other asset classes such as international stocks, real estate, gold, and bonds have not fared nearly as well this year (emerging markets have even experienced a bear market, dropping over 20% from the high levels seen in January). The prospects for the remainder of 2018 are somewhat positive for global asset growth, but many experts believe volatility will remain prevalent in upcoming months as trade negotiations are discussed further. Despite the outperformance of US stocks so far this year, it is important to remember to include a broad range of asset classes in your portfolio. While short-term trends and market noise can make it tempting to make knee-jerk decisions, 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

Crude Oil has now rallied and gained for five consecutive quarters- the most in more than a decade. Fueling the rally is the world’s tightening supply and increasing worries amongst consumers. With sanctions on Iran due to come into place and President Trump’s stern speech at the September 18th UN General Assembly concerning Iran, the world is bracing for increased tensions. Additionally, OPEC producer’s spare capacity is heading towards its lowest level since 2008, a time where oil was trading around $150 a barrel. Investors are cautiously watching upcoming months to see how oil demand progresses and whether the oil producers will be able to maintain supply while keeping prices steady.

*Chart source: Bloomberg

 

Market Update

Equities

Broad equity markets finished the week negative as large-cap stocks experienced the largest losses. S&P 500 sectors were mixed with defensive and sensitive sectors outperforming cyclical sectors.

So far in 2018 technology, consumer discretionary, and healthcare are the strongest performers while consumer staples and materials have been the worst performing sectors.

Commodities

Commodities were positive last week and outperformed other asset classes as oil prices increased by 3.49%. Oil increased as President Trump reaffirmed the United States position on Iranian Sanctions. Current sanctions have tightened the global supply even as OPEC countries increase production. Some of the world’s buyers of Iranian oil are already taking positions on the political issue. Japan, South Korea and two of India’s largest companies have committed to halting purchases ahead of the November deadline, although they can still change course ahead of the deadline. Amidst the news, OPEC and non-OPEC producers are discussing potentially increasing supply by 500,000 barrel a day.

Gold prices fell 0.39%, breaking a two-session rising streak and hitting a 6-week low. The Fed raising interest rates along with strong economic data helped the dollar strengthen, pushing the metal lower during the week. A stronger dollar makes gold, a dollar-denominated metal, more expensive to purchase for foreign investors.

Bonds

The 10-year Treasury yield fell slightly from 3.07% to 3.05%, resulting in positive performance for traditional US bond asset classes. Investors received the FOMC message last week as no longer accommodative and pushed yields slightly higher intra-week. By week-end the 10-year rate fell as the Feds preferred inflation index (personal consumption expenditures) remained unchanged during the month of August. In the upcoming weeks, investors will be watching other economic indicators to gauge the direction of the U.S. economy for the remainder of the year.

High-yield bonds were positive for the week as credit spread tightened. 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 small-cap US stocks leading the way and traditional bond categories lagging behind.

 

Lesson to be learned

You can’t predict the future, but you can prepare for it.”

– Howard Marks.

Nobody can predict exactly what is going to happen in the future. Nobody knows with 100% certainty when market tides are going to shift (see the dot-com bubble in 2000 or the financial crisis of 2008). However, sticking to a disciplined investment strategy and including a diverse basket of asset classes in your portfolio can help you increase the odds of success in the long-term, helping you better prepare for the uncertainty the future brings.

 

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 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 23.97, forecasting further economic growth and not warning of a recession at this time. The Bull/Bear indicator is currently 100% bullish – 0% neutral – 0% bearish. This means the indicator believes there is a slightly higher than average likelihood of stock market increases in the near term (within the next 18 months).

 

The Week Ahead

The coming week will be plentiful with economic data, but the employment report to be released on Friday should be the most impactful.

 

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.