Week in Review

Markets ended the week mostly flat as the longest government shutdown in US history came to a close.

Stocks started the holiday-shortened week on a negative note, with major indices losing over 1% on Tuesday as fears of a global economic slowdown increased. This was largely attributed to the International Monetary Fund (IMF) cutting its 2019 and 2020 global growth forecast over the weekend. The IMF now projects a 3.5% growth rate for 2019 and a 3.6% growth rate for 2020, down from its most recent forecast of 3.7% for both years. This is the IMF’s second downgrade in the past three months as it cited the trade war and weakness in Europe as potential headwinds for financial markets.

Despite the negative start, stocks rebounded later in the week as corporate earnings reports continued to show stronger than expected profits. Furthermore, President Trump signed a bill on Friday temporarily ending the 35-day government shutdown, which was the longest in US history. The bill will fund the government until February 15, providing congressional negotiators more time to work on an immigration reform deal.

Stocks have rallied significantly since the late December lows, with the S&P 500 gaining over 13.2% since Christmas. However, many indicators have been mixed recently. Last week, manufacturing data surprised on the upside and jobless claims fell below 200,000 for the first time since 1969, but existing home sales plunged 6.4% to the lowest level in three years. With conflicting signals, it is reasonable to expect continued heightened levels of volatility as markets remain sensitive to major headlines. This market noise 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 last time the S&P 500 posted a mostly flat weekly return, the Index dropped over 4% in the following week. While this does not imply causation for another sharp negative week ahead, it would be wise to avoid chasing the recent strong positive returns and keep recent performance in perspective. The previous four weeks added total gains of over 10% to the S&P 500, but last week’s flat performance could signal a pause in short-term momentum. With many indicators showing conflicting signals, it would not be out of the ordinary for markets to hit a resistance level and experience more downside volatility while searching for new levels of support.

*Chart source: Bloomberg

 

Market Update

Equities

Broad equity markets finished the week relatively flat as large-cap US stocks and international stocks experienced the largest gains. S&P 500 sectors were mixed, with cyclical sectors outperforming defensive sectors.

So far in 2019 energy and financial stocks are the strongest performers while utilities has been the worst performing sector.

Commodities

Commodities were negative as oil prices decreased by 0.20%. This is the first decline in four sessions for the commodity. Affecting oil prices in 2019 are the forces of supply and demand and stacking geopolitical risks. The market enjoyed a few weeks of “risk-on” as investors thought US-China trade tensions were nearing an end. However, US Commerce Secretary Wilbur Ross recently issued a statement saying the two countries were “miles and miles” away from an agreement, injecting more risk back into markets. Additionally, the US is currently considering placing sanctions on Venezuela – a major oil producing country. In the upcoming months, investors will be carefully monitoring ongoing geopolitical risks to better determine its effect on supply and prices.

Gold prices increased by 1.21%, closing the week at $1,298.10/oz. The metal currently sits at a 7-month high as the US dollar fell ahead of the January 30th Fed meeting. Since current expectations are that the Fed will leave interest rates unchanged, the US dollar weakened as currency investors are typically attracted to economies with rising interest rates. Additionally, Gold is a US dollar denominated safe haven asset. This means the metal typically performs best when interest rates are low and stocks are experiencing heightened volatility. Currently, analysts believe if Gold was to cross the $1,300 mark it could continue to climb higher as this seems to be a psychological resistance level.

Bonds

The 10-year Treasury yield decreased from 2.79% to 2.76%, resulting in positive performance for traditional US bond asset classes. Intra-week, the 10-year yield fell lower as investors bought treasuries amidst rising political tensions. However, on Friday yields increased as President Trump announced a deal to reopen the government for three weeks, sending yields higher. Since interest rates and prices have an inverse relationship, as yields fall, prices tend to rise. As we continue into 2019, investors will be watching the 10-year yield relative to 2-year yield to better gauge the direction of the economy.

High-yield bonds were negative for the week as riskier asset classes fluctuated and credit spreads loosened. However, as long as 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 mostly positive so far in 2019, with small-cap stocks leading the way and traditional US bonds lagging behind.

 

Lesson to be learned

The most important quality for an investor is temperament, not intellect.”

– Warren Buffett

While many investors are intelligent, a major flaw for most is the lack of temperament to control the urges that can get them into trouble. It can be tempting to make decisions based on short-term market noise and trends. However, for investors to be successful they must understand investing is a long-term process over many years. This is why it is important to stay disciplined, sticking to an emotion-free investment strategy and long-term plan. By taking emotions out of the equation, we can avoid making irrational decisions based on market noise and improve our odds for success in the long-term.

 

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 28.30, forecasting further economic growth and not warning of a recession at this time. The Bull/Bear indicator is currently 100% bearish, meaning the indicator shows there is a slightly higher than average likelihood of stock market decreases in the near term (within the next 18 months).

 

The Week Ahead

Earnings season is entering its busiest period as 25% of S&P 500 companies will be reporting results this week. Investors will also be keeping an eye on a meeting between the US and China on January 30-31 in attempt to reach a trade deal.

 

More to come soon.  Stay tuned.

Regards,

Derek Prusa, CFA, CFP®
Senior Market Analyst