Week in Review
Global markets traded lower for the week as interest rates spiked to seven-year highs following strong jobs data.
The 10-year treasury yield closed at 3.23% on Friday – the first time interest rates have reached this level since 2011. Only a month ago, the 10-year treasury yield was as low as 2.90%. A sharp upward movement in interest rates was experienced on Wednesday after a stronger than expected private-sector payrolls report. Labor market momentum continued into Friday as it was announced that the labor market added 134,000 jobs last month. Though this was lower than the expected gain of 185,000, many experts believe this was an anomaly as Hurricane Florence caused many businesses to shut down near the end of the survey week. Looking deeper into Friday’s report, previous months experienced strong upward revisions in payroll gains and the unemployment rate fell to 3.7% – the lowest reading since 1969.
While interest rates seem to be climbing for the right reason (strong economic growth), the rapid acceleration has sparked concern that inflation may increase more than currently anticipated and cause the Fed to “overtighten,” hindering further economic growth. Fears were amplified after Fed Chairman Jerome Powell stated the Fed would “act with authority” if inflation materially changes. This caused the CBOE Volatility Index, a popular measure of expected volatility in the S&P 500, to rise over 20%, resulting in downward pressure in broad stock markets.
After another bumpy week of trading, investors are hoping the upcoming earnings season will provide support for further gains. The estimated earnings growth rate for the S&P 500 is 19.2%, which would mark its third highest growth rate since 2011 if achieved. Strong earnings and economic data have continued to support US stock markets despite the ongoing geopolitical risks experienced so far this year.
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 and interest rates continue to gradually rise. 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
The NYSE FANG+ index – a group of tech stocks that includes Facebook, Amazon, Netflix, and Google – has been trailing behind the S&P 500 since the peak of June 20, 2018. The Index is down 12.5% compared to the S&P 500, which is up 4.3%. Higher interest rates and increased trade tensions have put a stop to the last decade’s top performers, reminding us of the need for diversification. The tech-heavy NASDAQ composite fell 3% last week while the S&P 500 fell only 1%.
*Chart source: Bloomberg
Broad equity markets finished the week negative as small-cap stocks experienced the largest losses. S&P 500 sectors were mixed with defensive sensitive sectors outperforming cyclical sectors.
So far in 2018, technology, consumer discretionary, and healthcare are the strongest performers while consumer staples, telecommunications, and materials have been the worst performing sectors.
Commodities were positive last week and outperformed other asset classes as oil prices increased by 1.49%. Crude oil has now increased for four consecutive weeks and reached 4-year highs as analysts predict looming Iranian sanctions could cause a supply shock. Latest reports show India, the world’s third-biggest oil importer, might purchase 9 million barrels of Iranian oil in November, increasing concerns surrounding possible geopolitical tensions with the US. Additionally, strong US economic data suggests that consumers might be willing to put up with high oil prices.
Gold prices increased by 0.81%, closing above $1,200/oz for the first time in 5 weeks. The latest interest rate hike, along with strong economic data, helped the dollar strengthen during the week. Typically, a stronger dollar weakens gold. However, the decline in equity markets strengthened the metal last week as investors fled to safety. Despite the gain, gold has declined 12 percent since hitting its peak in April. Investors are currently analyzing whether current prices provide a support level or if further losses can be expected.
The 10-year Treasury yield rose from 3.05% to 3.23%, resulting in negative performance for traditional US bond asset classes. The jump in the 10-year treasury bond put yields at the highest level in seven-years as unemployment also reached the lowest in 49 years. Additionally, the 30-year bond was up to 3.40%, the highest since 2014. This is fairly positive for the US economy as higher long-term interest rates steepen the yield curve. 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 negative for the week as riskier asset classes dropped by week-end and the credit spread loosened. However, 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
“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.
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 22.12, 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
Investors will be looking forward to the kickoff of Q3 2018 earnings season as multiple major banks report data on Friday.
More to come soon. Stay tuned.
Derek Prusa, CFA, CFP®
Senior Market Analyst