Week in Review February 19th, 2019

Stocks surged on rebounding consumer sentiment and optimism regarding US – China trade talks.

Just a week after trade uncertainties caused markets to pause, stocks rallied on trade agreement optimism. On Tuesday, President Trump said he is open to extending the deadline to raise tariffs on Chinese products if the two countries are close to a deal by the beginning of March. These comments were perceived as a strong indication President Trump is willing to provide more time to firm up a deal and avoid further conflict between the countries. Chinese President Xi Jinping met US trade representatives on Friday to continue discussions.

Strong consumer sentiment also helped boost markets, supported by the end of the partial government shutdown. The final January consumer sentiment report saw the largest drop in seven years, falling to two-year lows. However, the first report in February showed a strong gain, recuperating most of January’s loss. Business expectations helped drive the indicator higher as it is believed the Fed is set to pause interest rate hikes, which would be more accommodative for further business and economic expansion.

The positive news throughout the week helped offset other negative reports. Most notably, retail sales came in far weaker than expected and marked the largest monthly drop since September 2009. This suggests holiday spending did not meet expectations. While stocks have rallied significantly since the late December lows, with the S&P 500 gaining over 18% since Christmas, markets are still over 5% off their all-time highs. With conflicting signals and reports, 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

So far in 2019 the S&P 500 has posted positive returns in six out of seven weeks. The gains come after a difficult Q4 2018, and a particularly dreadful December. If the quarter ended today, the US stock benchmark would post its strongest quarter of gains since Q1 2012. The chart below illustrates the S&P 500 has been positive in over 70% of trading sessions during the first quarter of 2019. If this holds, it would be the highest winning percentage in a quarter since 1955. However, prudent investors should remain cautious as investors often fall trap to negative behavioral biases in times of heightened optimism.

*Chart source: Bloomberg

Market Update

Equities

Broad equity markets finished the week positive as small-cap US stocks experienced the largest gains. S&P 500 sectors were positive, with cyclical sectors outperforming defensive sectors.

So far in 2019 industrial and energy stocks are the strongest performers while utilities has been the worst performing sector.

Commodities

Commodities were positive as oil prices increased 5.44%. Prices have begun to pick back up as the US-China trade deadline looms. Additionally, supply pressures such as sanctions on Venezuela and OPEC production cuts have been supporting prices in recent weeks. For the first half of February, Saudi oil exports fell by over 1.3 million barrels per day (bpd) as OPEC countries committed to reducing production levels in 2019.  Analysts predict prices will rebound throughout 2019 as global supply levels continue to drop and geopolitical tensions remain relevant.

Gold prices increased by 0.33%, closing the week at $1,318.10/oz. The metal experienced mild gains as equities rose and volatility remained suppressed. However, investors aren’t discounting the relevance of geopolitical risks, especially with many deadlines approaching soon. As interest rates remain stable the future of gold prices is left to technical gauges and supply and demand. Gold is a US dollar-denominated safe-haven asset, which means it typically performs best in periods of heightened volatility and low interest rates. Since the metal broke over the $1,300 mark in late January, it has continued to climb higher. Upcoming weeks should shed some light on if the $1,300/oz price remains a support level for gold.

Bonds

The 10-year Treasury yield increased from 2.63% to 2.66%, resulting in slightly negative performance for traditional US bond asset classes. As the 10-year yield increased, the 2-year yield experienced a similar rise as investors are flocking to both ends of the yield curve over split recession expectations. However, if the fed continues down the now perceived dovish path it has set out in 2019, it could pave the way for relatively stable treasury yields. Currently, the spread between the 10 and 2-year yield decreased from 0.16% to 0.14% over the last week. Historically, when the spread turns negative a recession follows within a year or two.

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 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.

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 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 as the March deadline approaches.

More to come soon.  Stay tuned.