Markets were hit with another string of negative news during the holiday-shortened week, resulting in the worst week (and month) for US stocks since December 2018. The general “risk-off” outlook persisted throughout most of the week as the trade dispute between the US and China appeared to deepen. Furthering the conflict, President Trump reiterated he was nowhere near ready to make a deal, while China stated it would establish a list of unreliable entities to block doing business with Chinese firms in retaliation for the Huawei ban. With the two countries seemingly close to closing a deal back in early May, the deterioration in negotiations in recent weeks has left many investors seeking safety.
Trade policy took another unexpected turn late Thursday as it was announced the US plans to impose a 5% tariff on all imports from Mexico starting June 10, with gradual increases up to 25% by October. This was surprising news as the US just recently agreed to lift tariffs on metal imports from Mexico and Canada in a step to finalize a North American Free Trade Agreement (NAFTA) replacement.
Despite rising geopolitical uncertainties, the week had some positive economic reports to limit the downside. Consumer sentiment rose to an eight-month high in May, supported by a strong job market. Personal income and spending also increased more than expected, illustrating individuals are still comfortable spending money as they receive higher wages (which is typically a sign of a healthy economy).
Though markets have been more volatile in recent weeks, it is important to remember the S&P 500 is only 6.5% off its all-time-high closing level from late April. Even so, the past few weeks illustrate how important it is to stay committed to a plan and maintain a well-diversified portfolio. While stocks have slipped from their highs, other asset classes (such as gold, REITs, and bonds) have experienced more positive performance. Flashy news headlines can make it tempting to make knee-jerk decisions. However, 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
The S&P 500 closed the month down roughly 6.6%—making it the third worst May since the 1960s. A common phrase tossed around is “sell in May and go away.” While it may sound catchy, this is not necessarily the best investment strategy to adhere too. To examine this, we took a look at the last 21 years and noted returns in Q2 (April, May, June) were positive 15 of those years. Additionally, analyzing the following summer, in Q3 (July, August, September) the index closed positive on 12 separate occasions. A negative month like this past May should not scare away investors as long as fundamentals remain sound.
*Chart source: Bloomberg
Broad equity markets finished the week negative as international stocks fared better than domestic stocks. S&P 500 sectors were also negative, with defensive sectors outperforming cyclical sectors.
So far in 2019, real estate and technology are the strongest performers while healthcare has been the worst performing sector.
Commodities were negative for the week as oil prices decreased by 8.75% to $53.50/bl. This is the second consecutive sharp drop since the commodity dipped below the $60/bl level on May 23rd. In the short-term, the $60 price level could act as a “price ceiling” for additional increases as it has done in the past. The fall in prices came as investors continue to price in high US crude inventories along with trade tensions. On Friday, President Trump announced the US will be imposing a 5% tariff on Mexican imports, effective June 10th, with the ability to increase as long as illegal immigration remains a prevalent problem. Additionally, trade negotiations have stagnated in recent weeks with sentiment leaning towards additional complications as the US and China remain at a standoff.
Gold prices increased by 1.73%, closing the week at $1,305.80/oz. The increase came as trade tensions rattled the market with China threatening to blacklist foreign firms they deem damaging to their interests. During last weeks’ volatility, the dollar held steady while the 10-year treasury yield took a hit. As a weaker dollar and higher volatility provides the perfect atmosphere for gold to experience gains, investors have been purchasing the metal to hedge against further market decreases. Going into the remainder of 2019, gold has the potential to rise if current tensions persist.
The 10-year Treasury yield decreased from 2.32% to 2.12%, marking a fresh 20-month low, and resulting in positive performance for traditional US bond asset classes. During the week, Treasuries experienced increased demand as investors looked to hedge against trade tensions and new tariffs. The two-year note yield fell below 2% as investors sought safe haven in the short end of the yield curve as well. If geopolitical tensions were to persist, some analysts have noted the 10-year yield could fall as low as 1.75% by year-end.
High-yield bonds were negative for the week as riskier asset classes fell and credit spreads loosened. However, 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 traditional US bonds lagging behind.
Lesson to be Learned
The market will not go up unless it goes up, nor will it go down unless it goes down, and it will stay the same unless it does either”
– George Goodman
Short-term market swings can, and will, frustrate even the most experienced investors. Nobody knows which ways markets are going to move in any given day or week. This is why it is important to ignore short-term market noise and focus on the longer-term trends. If you stick with a plan and maintain a properly diversified portfolio, you increase your chances for portfolio growth over the long-run.
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 29.29, forecasting further economic growth and not warning of a recession at this time. The Bull/Bear indicator is currently 33.33% bullish – 66.67% 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).