Week in Review

Following the strong start to 2019, markets paused as trade was thrust back into the spotlight.

The US-China trade war took center stage again after taking a back seat to earnings announcements and the Fed in recent weeks. On Thursday, a senior administration official stated it was “highly unlikely” a meeting between President Trump and Chinese President Xi Jinping would take place before the March 2 deadline. If a deal is not reached by this deadline, the tariff rate on $200 billion of Chinese goods is set to increase from 10% to 25%. While it is still uncertain exactly what will happen if there is nothing in place prior to March, two administration officials stated the likely outcome is tariffs will remain at the current 10% rate as both sides seem willing to continue working toward a deal.

This caused markets to pull back later in the week after posting solid gains Monday and Tuesday. Coincidently, the S&P 500 bumped up against its 200-day simple moving average – the average of the Index’s closing price over the last 200 days. Many investors use this as a signal of bullishness or bearishness (when prices are above the 200-day average it means markets are in an uptrend, but when prices are below the average it means markets are in a downtrend). Because it is so widely followed, this can be a critical psychological threshold for markets, acting either as a resistance level against further gains or as a launching pad for a continued rally.

Stocks have rallied significantly since the late December lows, with the S&P 500 gaining over 15% since Christmas. However, markets are still over 7% off their all-time-highs. With conflicting signals and trade uncertainty, 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

There has been a lot of buzz recently about how Brexit negotiations are currently affecting the United Kingdom and surrounding eurozone areas. The most recent report from the UK showed GDP dropping 0.4% on a month-over-month basis and increasing a mild 0.2% on a quarter-over-quarter basis. This is among the lowest readings in the last four years and contributes to increasing global growth worries. Given the data, economists are currently placing a 30% probability the country will fall into a recession soon. If an exit deal isn’t secured by the March deadline and the UK decides to push forward, the remainder 2019 could be riddled with significant headwinds.

*Chart source: Bloomberg

 

Market Update

Equities

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

So far in 2019 industrial and real estate stocks are the strongest performers while healthcare has been the worst performing sector.

Commodities

Commodities were negative as oil prices decreased 4.60%. Oil prices fell largely because of returning trade tensions and global growth concerns. However, as markets experienced additional volatility, Venezuelan sanctions kept supply levels at bay, providing some price support. Additionally, in January Saudi Arabia reduced its oil output by 400,000 barrels per day (bpd), to 10.4 million bpd. This could continue to provide price support as supply levels in the market tighten. Analysts predict prices will rebound through 2019 as supply and demand forces drive markets.

Gold prices declined by 0.27%, closing the week at $1,318.50/oz. The metal dropped in an overall mixed week of trading for all asset classes, despite geopolitical risks returned to markets. However, increasing global growth worries along with a hold on interest rate hikes could provide a lucrative environment for the metal to rise. Last year, gold was heavily impacted by rising rates driving the dollar higher. Since the metal is a dollar-denominated asset, a stronger greenback makes the metal more expensive for foreign investors. Currently, analysts believe if gold can hold above the $1,300 mark it could continue to climb higher.

Bonds

The 10-year Treasury yield decreased from 2.73% to 2.63%, resulting in positive performance for traditional US bond asset classes.  The treasury market is seeing increased activity since investors now believe the US and China will be unsuccessful in coming to a trade agreement by March. Additionally, growing concerns about global growth and US economic productivity helped fuel demand. In 2018, a big concern was the spread between the 10 and 2-year treasury. If short term-rates rise above long-term rates, the yield curve becomes inverted, which is typically seen as a precursor to recessions. However, so far in 2019 the spread between both ends seems to be widening, reaching a high of 20bps – a positive sign for markets.

High-yield bonds were positive for the week as riskier asset classes rose. 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 positive so far in 2019, with small-cap stocks leading the way and traditional US bonds lagging behind.

 

Lesson to be learned

If investing is entertaining, if you’re having fun, you’re probably not making any money. Good investing is boring.”

– George Soros

It can be easy to get caught-up in the excitement of chasing a “hot” investment tip. This can make for great dinner party conversation if you are lucky enough to hit it big, but continuously speculating is not a sustainable way to achieve investing success. If you want to be successful in the long-run, it is important to base investment decisions on rational information and maintain discipline to a strategy over time. By taking emotions out of the equation, we can avoid making irrational mistakes which can be detrimental to a portfolio when luck runs out.

 

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 29.56, forecasting further economic growth and not warning of a recession at this time. The Bull/Bear indicator is currently 66.67% bearish – 33.33% bullish, 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 winding down as a majority of companies have already reported results. Congress hopes to reach a funding agreement to avoid another partial government shutdown as the Friday deadline looms.

 

More to come soon.  Stay tuned.

Regards,

Derek Prusa, CFA, CFP®
Senior Market Analyst