Week in Review
US stocks posted the strongest week of 2018 as major indices rebounded sharply from Thanksgiving woes.
Following a record-breaking Black Friday, US stock markets started the week on a strong note as data revealed overall spending was up 6.1% year-over-year compared to 2017 numbers. While there is still a long way to go for the entire holiday shopping season, initial results are looking promising for retailers. The fundamentals for continued sales growth remains strong as a strong labor market and tax cuts have given consumers more freedom to increase spending.
Markets received another boost on Wednesday as Fed Chairman Jerome Powell stated the central bank’s policy rate is now just below neutral, signaling a slowdown in future rate hikes. This was a notable change in tone from the remarks Powell made in early October when he said the Fed was “a long way” from neutral. Investors cheered the shift in tone as lower rates are seen as more accommodative for further economic growth. The Fed is expected to hike rates again in December, but the outlook for 2019 and beyond is still murky, with anywhere from one to three increases projected.
Investors are hoping the holiday-fueled rally continues into the end of the year. Short-term “newsworthy” events have been intensifying market noise recently, making it difficult to focus on the fundamental drivers behind markets. However, as long as the economy remains healthy and earnings continue to grow, there is the potential for further market gains (though many expect volatility to persist in the foreseeable future). 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
Fed President Jerome Powell’s speech on November 28th helped take some perceived risk off the table. Investors were willing to put their chips back in as Powell stated he considers the benchmark interest rate to be near a neutral level. The iShares Russell 1000 Growth ETF, a common growth stock benchmark, saw $353 million in inflows last week- the second largest level this year. Simultaneously, a portfolio tracking growth stocks, the Bloomberg U.S. Pure Growth Portfolio, saw its largest weekly gain since August 2011. As the market is beginning to price in the possibility of steady interest rates, investors are becoming attracted to potentially taking higher levels of risk once again. Growth stocks are typically more sensitive to rising rates due to their lack of dividends and high valuations. Looking back to October when rates hit their highest level since 2011, growth stocks posted their largest decline in over a year.
*Chart source: Bloomberg
Broad equity markets finished the week positive as large-cap US stocks experienced the largest gains. S&P 500 sectors were positive, with cyclical sectors outperforming defensive sectors.
So far in 2018 healthcare, consumer discretionary, and technology are the strongest performers while materials and communication services have been the worst performing sectors.
Commodities were slightly negative despite oil prices increasing 1.01%. This is the first increase for oil in eight weeks. Despite the gain, oil posted its worst month in over 10 years, falling roughly 22% in November. Fueling negative sentiment are rising US crude inventory levels, which continue to come in higher than market estimates. The market believes there is currently an oversupply of oil. Investors are currently waiting for the upcoming OPEC meeting on December 6th to better understand the future direction of supply levels. In the meantime, some market analysts believe that the recent drop in oil might be pushing the commodity close to its bottom.
Gold prices fell by 0.25%, closing the week at $1,226.00/oz. The metal traded in a tight range as future interest rate prospects are now expected to be lower but supply remains a relevant risk. Gold, a safe-haven asset class, typically performs better in low and steady US interest rate environments as foreign investors don’t have to pay a premium for the metal. As the dollar strengthens, gold typically becomes less attractive for foreign investors.
The 10-year Treasury yield fell from 3.05% to 3.01%, resulting in mostly flat performance for traditional US bond asset classes. Intra-week the yield dipped to as low as 2.995%. The fall comes after Fed President Jerome Powell’s dovish comments in his speech mid-week. Additionally, investors braced for a more “risk on” outcome from the G20 summit. Going into the last month of the year, investors expect a final rate hike with the possibility of a slowdown in 2019.
High-yield bonds were positive for the week as riskier asset classes performed strongly and credit spreads tightened. As long as economic fundamentals remain 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
A lot of people with high IQs are terrible investors because they’ve got terrible temperaments. You need to keep raw, irrational emotion under control.”
– Charlie Munger
While intelligence is important for creating an investment strategy, many investors struggle with keeping emotions intact. It can be easy to get caught-up in short-term market movements, letting emotions drive the decision-making process and deviating from the plan. However, this is often when investors make the worst financial decisions, causing the most harm to their portfolios. By staying disciplined and sticking to an emotion-free investment strategy, you can avoid irrational missteps and increase the odds of 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
Investors will be watching to see how markets react following the meeting between US President Donald Trump and Chinese President Xi Jinping regarding tariffs. Also, November’s employment report will be released Friday morning.
More to come soon. Stay tuned.
Derek Prusa, CFA, CFP®
Senior Market Analyst