Week in Review
After the worst Christmas Eve ever for US stocks, markets rebounded to finish the week positive.
The S&P 500 started the week on a negative note, with the Index falling 2.71% on Monday – Christmas Eve. This marked the first time in history the S&P 500 has recorded a loss of more than 1% on the last trading day before Christmas. The prior largest decline for the Index on the day before Christmas was a 0.91% loss in 1933 (during the Great Depression). Nagging concerns about the Federal Reserve raising rates too quickly coupled with a government shutdown carried over through the weekend, weighing on sentiment to start the week.
However, following the market closure on Tuesday for Christmas, US stocks surged on Wednesday in the biggest single-day rally since March 2009. Consumer Discretionary stocks, such as Amazon, led the charge higher on positive reports about consumer spending during the holiday season. This sent major indices up around 5% for the day as investors jumped back into markets to take advantage of potential oversold conditions. When the week was finished, stocks closed modestly higher, snapping the sharp losing streak that started in early December.
While the week ended positive, there are still many uncertainties remaining, such as the Fed rate policy for 2019, trade tensions, and the government shutdown. Despite these geopolitical concerns, economic and corporate fundamentals still remain strong. 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
It has been 15 trading days since the S&P 500 fell through the floor of the triangle consolidation pattern that had been forming. Since then, the Index has dropped roughly 7.6%, bringing its year-to-date total return to -5.4%. Although this downward movement has been abrupt, downturns like this are common over full market cycles. However, in order for a more bullish trend to take charge, markets will need to find a new floor and level of support amid continued volatility.
*Chart source: Stockcharts
Broad equity markets finished the week positive as small-cap US stocks experienced the largest gains. S&P 500 sectors were mostly positive, with cyclical sectors outperforming defensive sectors.
So far in 2018 utilities and healthcare are the only positive performers while materials and energy have been the worst performing sectors.
Commodities were negative as oil prices decreased by 0.57%. This is the third consecutive weekly loss for oil as the commodity remains in bear market territory. Uncertainties about global economic growth continues to pressure prices. Additionally, U.S. crude oil inventories continue to surprise investors coming in at high levels. Last week, U.S. crude inventories were down 46,000 barrels. The decrease in stockpiles, however, wasn’t enough to provide hope for investors. Currently, analysts expect prices to rebound in 2019 as Iranian sanction waivers fall off and global risks tapper.
Gold prices increased by 1.95%, closing the week at $1,283.00/oz. The metal rose as stocks experienced another volatile week of trading and the US dollar fell against a basket of foreign currencies. The dollar weakened as the prospect of interest rate hikes in 2019 fell from three to two following the December 19th Fed meeting. Since gold is dollar-denominated it generally performs best when interest rates are low and steady. Gold has been a viable method to hedge risk in recent weeks, as investors have been seeking safety amid stock market volatility.
The 10-year Treasury yield fell from 2.79% to 2.72%, resulting in positive performance for traditional US bond asset classes. As the market continues to price in fewer than expected interest rate hikes, spreads continued to tighten. Currently, the 2 & 10-year spread sits at 0.20%, 34 basis points lower than the beginning of the year. Although the 2 & 10-year spread inversion has historically preceded recessions, years of fed intervention has some analysts believing this time could be different. Going into 2019, investors will be watching geopolitical and market events in order to gauge the need for safe-haven Treasuries.
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.
Most asset class indices are negative in 2018, with US Treasury Bonds leading the way and commodities lagging behind.
Lesson to be learned
Your success in investing will depend in part on your character and guts and in part on your ability to realize, at the height of ebullience and the depth of despair alike, that this too, shall pass.”
– Jack Bogle
Over time, stock markets have experienced swings from extreme optimism to extreme pessimism. Some of the greatest opportunities can be found at these extreme levels, but it can often feel like the wrong decision at the time when things continue to go very well or very poorly. It is important to understand various investment environments do not last forever – markets tend to work in cycles. This is why it is important to stay disciplined as an investor, 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.
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 24.46, 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
Monday is the last trading day of 2018. With markets closed for the New Year holiday, investors will be watching to see if stocks can start 2019 on more positive footing following a volatile year.
More to come soon. Stay tuned.
Derek Prusa, CFA, CFP®
Senior Market Analyst