Stocks Extend Gains During Holiday-Shortened Week

WEEKLY MARKET UPDATE – July 8, 2019

Stocks extended their gains during the holiday-shortened week as major headlines dominated market movements. The week started on a strong note following mostly positive news from the G20 Summit. While the US and China did not reach a trade deal, the two countries agreed to resume trade talks. China said it would purchase more US agricultural products while the US confirmed it would not be adding tariffs on $300 billion of Chinese imports and would also allow US companies to continue selling to Chinese company Huawei – a move many investors viewed as a large step in the right direction.

The momentum continued on Wednesday as a disappointing private-sector payrolls report raised expectations of a Fed rate cut. However, major stock indices closed the week slightly off all-time-high levels as a strong jobs report on Friday dashed the hopes of a dovish Fed. The US economy added 224,000 jobs, easily beating the expected gain of 164,500. Longer-term Treasury yields surged higher following Friday’s job report as the implied probability for a rate cut in July fell 8% according to the CME Group’s FedWatch tool.

Recent weeks have seen strong gains in US stock markets, but the volatility from the past few months illustrates how important it is to stay committed to a plan and maintain a well-diversified portfolio. Stocks have reached new all-time-highs just to fall over 6% in a month and rebound back to new highs again, but other asset classes (such as gold, REITs, and bonds) have experienced more steady, positive performance.

Flashy news headlines can make it tempting to make knee-jerk decisions, but sticking to a strategy and maintaining a portfolio consistent with your goals and risk tolerance is imperative for long-term success. Including a broad mixture of asset classes can help with achieving more consistent long-term results, smoothing the short-term market noise and making it easier to weather these common volatility storms.

Chart of the Week

From the first sign of volatility in May, investors have been pricing in a rate cut, pushing Treasury yields lower. Since the market rout last year was mostly attributed to the aggressive rate hikes taken by the Fed, investors now see the only way to avoid additional pullbacks is to walk back those steps. However, what the market is implying through investor actions (buying US treasuries causing the yields to go down) and what the Fed is actually planning to do are two different things. Despite, investors consensus pointing towards a cut, the Fed’s effective rate remains at 2.25%-2.50% range. Additionally, the Fed has only just recently mentioned a “willingness” to cut rates if data deteriorates. Last Friday’s job report confirmed that the economy remains healthy causing some investors to walk back their expectations of future rates.

*Chart source: Bloomberg

Market Update

Equities

Broad equity markets finished the week mixed as large-cap US stocks fared better than small-cap stocks. S&P 500 sectors were mostly positive, with cyclical sectors outperforming defensive sectors.

So far in 2019, technology and consumer discretionary stocks are the strongest performers while healthcare has been the worst performing sector.

Commodities

Commodities were negative for the week as oil prices decreased by 1.64% to $57.51/bl. This is the first decrease in three weeks as G20 events were perceived positively by investors. However, by week-end, oil prices began to climb as tensions with Iran increased. Additionally, OPEC and its allies agreed to extend supply cuts through the year. However, holding back stable prices continues to be mixed economic data which is flashing red in some parts of the globe. The US is showing strong job growth while other countries such as Germany have been showing weakening manufacturing data. As we continue through the year, investors will constantly reassess geopolitical risks along with supply and demand forces to properly gauge future oil prices.

Gold prices fell by 0.71%, closing the week at $1,401.60/oz. This is the first decrease in three weeks and only the second week of the metal closing above $1,400/oz. Gold fell by week-end as strong US jobs growth pushes yields higher and lowered the prospects of a rate cut. Additionally, news that the US and China will resume trade talks and a successful meeting between President Trump and Kim Jung Un of North Korea helped lift risk from markets. Since the metal is a US dollar-denominated safe-haven asset, it tends to perform best when interest rates are low and volatility is high. However, current levels are far from yearly lows and the potential for further price increases remain possible.

Bonds

The 10-year Treasury yield rose from 2.00% to 2.04%, resulting in negative performance for traditional US bond asset classes. Treasuries jumped above the 2% level by week-end as a strong US jobs report helped reassure investors in the strength of the economy and the durability of the bull market. However, despite the strong economic data, current Fed rate cut expectations sit at a 92% probability for the July meeting. This probability has dropped from 100% since Wednesday of last week,

High-yield bonds were positive for the week as riskier asset classes were rose and credit spreads tightened. As long as US 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 large-cap US stocks leading the way and US Treasuries lagging behind.

Lesson to be Learned

We do the worst possible thing at the worst possible time because we are most certain that we are right just when we are most likely to be wrong.”

– Jason Zweig

Investors often cost themselves money because of irrational short-term behavior. When exuberance or fear set in people tend to act on emotions, leading them to make decisions at the worst time. The best way to avoid this irrational behavior is to implement a plan with predefined steps to take ahead of time. If you stick with a plan and maintain a properly diversified portfolio, you increase your chances for a successful investment outcome in the long-run.

FormulaFolios 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 at 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 29.19, forecasting further economic growth and not warning of a recession at this time. The Bull/Bear indicator is currently 100% bullish – 0% bearish, meaning the indicator shows there is a slightly higher than average likelihood of stock market increases in the near term (within the next 18 months).

The Week Ahead

All eyes will be on Fed Chairman Jerome Powell as he gives a testimony on Wednesday. The testimony will help set the expectation for a potential July rate cut.

More to come soon.  Stay tuned.