Week in Review
After a delay caused by the government shutdown, the first estimate of Q4 2018 GDP growth came in stronger than expected, leading stocks slightly higher for the week.
GDP grew 2.6% during the fourth quarter of 2018, beating the consensus estimate of 2.2%. This growth came during a period of heightened market uncertainty, where the S&P 500 almost closed in bear market territory in late December. Strong consumer spending helped boost GDP growth, contributing 1.9% to the increase (or accounting for about 75% of the increase). For 2018 as a whole, the economy grew at a rate of 2.9%, up from 2.2% in 2017.
Better than expected economic data helped broad stock indices close slightly higher for the week. The end of February marked the strongest two-month start to a year for the S&P 500 since 1991, with the Index gaining 11.1%. Furthermore, Friday’s gain helped the Index close above the resistance level of 2,800 for the first time since November. Approximately 90% of stocks in the S&P 500 Index are now above their 50-day moving averages, illustrating the recent rally has been wide-spread (as opposed to just a few large companies driving gains).
Stocks have rallied significantly since the late December lows, with the S&P 500 gaining over 19.2% since Christmas – less than 5% off its all-time-high. Following such a strong rally, the potential for further gains seems to be hinging on a US-China trade deal. Trade tensions have been a constant source of volatility over the past year, but optimistic reports have boosted investor sentiment in recent months. However, there are also still reasons to remain cautious, such as softening global growth. With conflicting signals and data, it is reasonable to expect volatility to persist 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
Since the Fed promised a more patient approach on future interest rate hikes, the 10-year treasury yield has traded within a range of 12 basis points. Relatively tight trading like this comes as a relief following a year of volatile treasury yield swings. Additionally, YTD, the correlation between the 10-year treasury yield and US stock markets (on a 90-day basis) has reached its lowest level in two years. Investors, however, should be cautious since yields often breakout after trading within a tight range for consecutive sessions. Upcoming weeks should shed some light on how markets react to ongoing trade negotiations between China and the US and whether or not additional positive trading sessions are ahead of us.
*Chart source: Bloomberg
Broad equity markets finished the week positive as international stocks experienced the largest gains. S&P 500 sectors were mixed, with cyclical sectors outperforming defensive sectors.
So far in 2019 industrial and energy stocks are the strongest performers while consumer staples has been the worst performing sector.
Commodities were negative as oil prices decreased by 2.55% to $55.80/bl. Oil dropped at week-end as the US ISM report came in slightly below expectations. Fear’s that slowing US manufacturing might cut global demand rippled through the commodities price. However, OPEC nations seem to be adhering to expected production reductions, pumping 300,000 less bpd in February than January. US energy mills have followed suit paving the way for possibly higher and stable oil prices in 2019. If demand remains healthy and supply levels contained, analysts expect the average price of oil to be $60-65 between 2019 and 2020.
Gold prices decreased by 2.52%, closing the week at $1,299.20oz. The metal fell the most it has during a week in over 6 months. The drop below the critical $1,300 level came as the US dollar rallied on the back of a nearing trade deal with China. Compared to a basket of foreign countries, the US economy is in a relatively healthy position, attracting foreign investors to our currency. Since the metal is US dollar-denominated, a stronger dollar makes it more expensive to foreign buyers and applies negative price pressure.
The 10-year Treasury yield increased from 2.65% to 2.76%, resulting in negative performance for traditional US bond asset classes. As the 10-year yield increased, the 2-year yield also increased, widening the spread between them to 20 basis points. Currently, the market expects one interest rate hike for 2019. With relatively steady rates ahead of us, treasury yields might be more influenced with market levels in 2019. Last week, investors sold off safe-haven treasuries in favor of riskier assets in the wake of calming geopolitical risks.
High-yield bonds were positive for the week as riskier asset classes rose and credit spreads tightened. 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
Spend each day trying to be a little wiser than you were when you woke up.”
– Charlie Munger
Financial markets are constantly changing and evolving. As investors, we need to remain agile and able to shift with broad market trends. However, many people have difficulty parting with a losing investment because “they just know it is going to turn around soon.” Eliminating emotions from the investment process can help with this. By taking emotions out of the equation, investors can make decisions based on rational information rather than their feelings, increasing the odds of success in the long-run.
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
Investors will be keeping an eye on progress toward a US – China trade deal. The US jobs report will also be released on Friday.
More to come soon. Stay tuned.
Derek Prusa, CFA, CFP®
Senior Market Analyst