Week in Review January 7th, 2019

Stocks Start 2019 on Positive Note Despite Continued Volatility

After more volatility, stocks closed the first week of 2019 higher as strong economic data and a “patient” Fed sparked a Friday rally.

Following the New Year holiday, markets started 2019 on a bumpy note. Global stocks tumbled on Thursday after Apple issued negative revenue guidance going into the upcoming earnings season. The company cited economic slowdowns in emerging markets (specifically China) as well as the ongoing trade dispute between the US and China resulting in lower than expected sales overseas. This sent major indices reeling as technology shares tumbled over 4% for the day.

However, broad markets rallied on Friday to finish the week in positive territory. Initially sparking the rally was stronger than expected jobs report. Payrolls increased by 312,000, well above the expectation of a 180,000 gain. While the unemployment rate increased from 3.7% to 3.9%, it was for a good reason as the labor force participation rate increased, signaling more people are starting to look for work.

Accelerating the gains on Friday, Fed Chairman Jerome Powell said the central bank will be “patient” in its approach to further rate hikes. Powell also stated the Fed would not hesitate to use all tools at its disposal if there were to be an economic downturn or financial unsteadiness. This helped ease concerns about Markets have been in turmoil in recent months as investors feared the Fed was becoming too aggressive in raising interest rates, which could result in an economic slowdown.

While the week ended positive, there are still many uncertainties remaining, such as the trade tensions and the government shutdown. Despite these geopolitical concerns, economic and corporate fundamentals still remain strong, as illustrated with the strong jobs report. 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

Since 2016, the S&P 500 and the ISM Manufacturing Index (a measurement of manufacturing activity and sentiment in the US) have been moving almost in lockstep. That is, until recently. Last week, investors sold off US stocks as the ISM Index dropped to a two-year low. However, stocks staged a comeback late in the week as payrolls came in impressively high on Friday. Now traders have two indicators that typically drive markets showing different sentiment. Upcoming weeks and next month’s readings will give a better direction to markets as investors look to establish patterns in stock and economic levels.

*Chart source: trading view

Market Update

Equities

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 2019 energy and communications are the strongest performers while technology and real estate have been the worst performing sectors.

Commodities

Commodities were positive as oil prices increased by 6.57%. This is the first gain in four weeks as the oil attempts to rebound from extreme losses in 2018. Oil prices gained as trade talks between the U.S. and China are set to take place on January 7th. However, additional gains were capped as the US Energy Information Administration showed rising US crude inventories and refiners utilizing 97.2% of capacity, a high rate compared to previous years in similar time periods.

Gold prices increased by 0.28%, closing the week at $1,286.65/oz. Additional gains were capped as the metal fell on Friday following a stronger-than-expected jobs report. Since gold is a U.S. dollar-denominated safe-haven asset, it performs best when there is heightened volatility across the market.

Bonds

The 10-year Treasury yield fell from 2.72% to 2.69%, resulting in a positive performance for traditional US bond asset classes. While yields closed the week lower, they jumped on Friday on the back of strong jobs report returning some confidence to investors. However, short-term yields moved higher than longer-term yields as investors speculate a continuing stream of positive data could speed up future rate hikes. Investors are also watching the 2 & 10-year spread inversion as it has historically preceded recessions. Continuing 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.

Asset class indices are positive so far in 2019, with commodities leading the way and traditional US bonds lagging behind.

Lesson to be learned

“The most important quality for an investor is temperament, not intellect.”

– Warren Buffett

While many investors are intelligent, a major flaw for most is the lack of temperament to control the urges that can get them into trouble. It can be tempting to make decisions based on short-term market noise and trends. However, for investors to be successful they must understand investing is a long-term process over many years. This is why it is important to stay disciplined, 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.

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 the 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

US and Chinese officials are set to restart trade talks this week. If negotiations appear to head in a positive direction, it could boost investor sentiment.

More to come soon.  Stay tuned.