Week in Review January 22nd, 2019

Boosted by Positive Trade Talks, Markets Continue Winning Streak

Markets continued the recent winning streak last week, boosted by positive trade negotiations between the US and China.

Stocks closed higher for the fourth straight week, the longest winning streak since August, as investors cheered potential progress in trade negotiations between the US and China. Major indices jumped on Friday as it was released China offered a six-year increase in US imports during the ongoing trade talks in Beijing earlier in January. According to reports, China would increase its annual imports by a combined value of over $1 trillion, reducing the US trade deficit to effectively $0 by 2024 (the US had a trade deficit of $323 billion with China in 2018). The trade deficit is a key factor in achieving a trade deal; if this issue gets resolved, a major headwind would be removed.

With investors mostly focused on trade talks, major banks reported earnings throughout the week. As a whole, earnings were stronger than many feared, sending the financial sector up over 6% during the week. Goldman Sachs even posted its largest one-day gain since 2009 after topping expectations. However, not all companies reporting earnings fared as well, as Netflix dropped after missing revenue forecasts.

While stocks have rallied significantly since the late December lows, with the S&P 500 gaining over 13.5% since Christmas, some indicators have been signaling signs of caution. Consumer sentiment fell sharply in January to its lowest level in over two years and the International Monetary Fund cut its estimates for global growth for 2019. However, the US labor market and corporate earnings have remained relatively 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

In less than a month, the S&P 500 has recouped over half its losses since dropping to new lows on Christmas Eve. The rally back over the 2,600 level could act as a much-needed floor price on which US stocks could use as support for a further rally. Additionally, Friday’s gain helped solidify the Index above its 50-day moving average, a line that provided resistance twice during the Q4 sell-off.

*Chart source: Bloomberg

Market Update

Equities

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 2019 energy and financial stocks are the strongest performers while utilities has been the worst performing sector.

Commodities

Commodities were positive as oil prices increased 4.28%. This is the third consecutive weekly gain as oil attempts to rebound from its extreme losses in 2018. Oil prices rose as China set forth a plan to eliminate its current trade surplus with the US by 2024. Although this plan would help lift geopolitical risk from the markets, investors are still concerned about supply and demand. Crude suffered in 2018 due to an apparent overproduction as risks related to supply from Iran were improperly weighed. In 2019, analysts will be closely watching US crude levels along with OPEC nation production levels to gauge whether oil rigs have adjusted output to compensate for lower prices.

Gold prices fell by 0.54%, closing the week at $1,282.60/oz. The metal fell as investor appetite returned to risk-on amidst a possible China-US trade deal and strengthening US equities. Since gold is a safe haven asset class, it generally performs best when there is heightened pessimism in the market. Currently, analysts believe if gold was to cross the $1,300 mark it could continue to climb higher as this seems to be a psychological resistance level.

Bonds

The 10-year Treasury yield increased from 2.71% to 2.79%, resulting in negative performance for traditional US bond asset classes. Since interest rates and prices have an inverse relationship, as the treasury yield increases, bond prices tend to fall. As we continue into 2019, investors will be watching the 10-year yield relative to 2-year yield to better gauge the direction of the economy. As investors grow bullish towards equities, they feel comfortable adding risk for higher returns. Additionally, Fed sentiment now appears slightly dovish and more on the cautious side, satisfying investor concerns about rapidly rising rates.

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

“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 28.30, 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

It will be a short week for traders as markets are closed on Monday for Martin Luther King Day. During the remainder of the week, earnings season will begin to heat up with more companies reporting results.

More to come soon.  Stay tuned.