Week in Review
Stocks finished higher for the week, but closed October with the worst monthly loss in multiple years.
A strong labor market continued to support stocks as the US economy added 250,000 jobs last month, beating the expected gain of 190,000. With strong jobs growth, the unemployment rate remained at 3.7% – its lowest level since 1969. While these numbers are consistent with the mostly positive trend in 2018, the major headliner from the report was wage growth. Average hourly earnings increased 3.1% from a year ago, marking the strongest growth rate since 2009. This illustrates the tightening labor market is finally translating into higher income for workers; a piece that has been missing during the recovery from the financial crisis.
While another strong jobs report provided relief from the recent sell-off, October closed as the worst month for stocks in multiple years. The S&P 500 Index had its worst month since 2011 (-6.84) while the tech-heavy NASDAQ Composite had its worst month since 2008 (-9.16). Leading the way lower, the once high-flying group of large-cap growth FANG stocks (Facebook, Amazon, Netflix, and Google) experienced losses between 7.70% and 20.22% in October. However, while stocks traded sharply lower, other asset classes held up more firmly as real estate was down less than 3% and bonds were down only around 0.6%.
This illustrates why it is so important to remember to include a broad range of asset classes in your portfolio and not get caught chasing the “hot” returns of just a few popular companies. Many low-risk investors have recently been worried about having bond exposure in their portfolios because of rising interest rates leading to lackluster performance. However, the past month shows bonds are still useful when it comes to reducing volatility and minimizing drawdowns. 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 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 S&P 500 has had a bumpy year so far as illustrated by the chart below. Unlike 2017, the index has tested its ability to withstand volatility five separate times, using the 200-day moving average as a critical support level. During the February correction, the moving average provided the support needed for the Index to rebound. However, on October 11, the index broke below the moving average turning old support level into new resistance. On November 2, the Index closed just below its 200-day moving average of 2764.66. Technical analysts believe if the index is able to break through its current resistance level, then it might find support and rally into 2019. However, if events continue to unfold negatively, investors should brace for more volatility going into the end of the year.
*Chart source: Bloomberg
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 technology, consumer discretionary, and healthcare are the strongest performers while materials and communication services have been the worst performing sectors.
Commodities were negative last week as oil prices decreased by 6.58%. This is the largest weekly decline since February 2018, bringing oil prices to a seven-month low. Prices fell as U.S. crude has been caught-up in a broader market sell-off where investors have been selling riskier assets. Sanctions on Iran are now in full effect with a list of eight countries who will be receiving waivers to be released shortly. Analysts expect that sanctions will reduce Iranian oil exports by roughly 1 million barrels a day. Investors are cautiously watching geopolitical events unfold in the coming weeks to better gauge how global demand may be affected.
Gold prices fell by 0.13%, closing the week at $1230.90/oz. The metal dipped by week-end end as job growth data and a strengthening dollar reaffirmed strong prospects for the US economy. Since gold is considered a safe haven asset, it performs best under periods of heightened volatility. Current economic conditions still point to a favorable environment for US equities despite the heightened volatility. Additionally, analysts estimate that current gold supply levels may not warrant its price level.
The 10-year Treasury yield rose from 3.08% to 3.22%, resulting in a negative performance for traditional US bond asset classes. The increase in the 10-year treasury bond came as volatility returned during the week following last week’s market rout. Following the strong US job report released on Friday, the 2-year treasury yield hit a level not seen since June 2008. Job data showed wage growth picking up – a sign that reaffirms the Fed’s actions and points to additional rate hikes ahead. In the upcoming weeks, investors will be watching other economic indicators to gauge the direction of rates for the remainder of the year.
High-yield bonds were positive for the week as riskier asset classes rebounded from a poor October and credit spreads 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 large-cap US stocks leading the way and international stocks lagging behind.
Lesson to be learned
In the short run, the market is a voting machine. In the long run, it is a weighing machine.”
– Benjamin Graham
Markets can behave like a popularity contest in the short-term as prices and trends can change quickly based on speculation and noise. However, in the long-term, market prices tend to reflect fundamentals. This is why having a concrete plan in place is so imperative. Sticking to a disciplined investment strategy can help take emotions out of the investment process and improve your chances for long-term success.
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 24.63, forecasting further economic growth and not warning of a recession at this time. The Bull/Bear indicator is currently 33.33% bullish – 33.33% neutral – 33.33% bearish. This means there is no clear direction of stock market movements for the near term (within the next 18 months).
The Week Ahead
US midterm elections will be held on Tuesday, November 6. Investors will be looking to see how markets react following this catalyst.
More to come soon. Stay tuned.
Derek Prusa, CFA, CFP®
Senior Market Analyst