Markets Pause Rally Over US – China Trade Pessimism
U.S. equity markets closed down for the week, with all major indices finishing in negative territory. The healthcare sector managed to finish in positive territory, leading financials and utilities as the only positive sectors. This week saw major earnings releases that had significant impact on the market. Most notably, Home Depot and Kohls’ earnings misses created a drag on markets. The trade war between the U.S. and China is also looking increasingly uncertain, as a “phase one” deal still has not been agreed upon.
European indices had a poor week, finishing down nearly across the board. European markets have shown a high degree of sensitivity to U.S. markets, typically following the prevailing U.S. market sentiments. The trade dispute between the U.S. and China has had a large impact on developed international markets, especially Europe and Japan. The Nikkei index finished the week down as well, as Japan is especially sensitive to global trade disruptions.
Even though major indices declined slightly this week, major market indices remain near all time highs. While this is good news, the volatility in recent weeks and months still serves as a great reminder of why it is so important to remain committed to a long-term plan and maintain a well-diversified portfolio. 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 can lead to smoother returns and a better probability for long-term success.
Chart of the Week
The spreads between CCC “junk” bonds and investment grade bonds have climbed to the highest levels since 2016, highlighting a move by investors to move into less risky assets. The climb in yields has largely been driven by energy bonds, as the energy sector continues to underperform the market as a whole. Margins are being squeezed as depressed commodity prices have taken a toll on the sector.
Broad equity markets finished the week mostly down, breaking a six-week winning streak, as investors turned slightly more pessimistic on trade outlooks.
S&P sectors were mixed but skewed mostly negative, with materials and real estate bottoming out -1.69% and -1.22% respectively. Healthcare and financials led the positive sectors with 0.81% and 0.46% respectively. Technology continues to lead the S&P sectors YTD with 39.36% growth.
Commodities were mostly flat this week, with slight declines in oil and natural gas. Oil markets have been highly volatile recently, with investors focusing on geopolitical tension and global demand concerns. Recent oil inventory numbers met expectations, bucking recent trends of repeated expectations misses. If U.S. – China trade optimism recovers, this will likely add upward pressure on oil prices, but short term fears are mostly outweighing longer term likely trade prospects.
Gold prices fell slightly this week, declining 0.33%. The market is continuing to wrestle with macroeconomic factors to determine appropriate value. The U.S. – China trade deal will likely be the determining factor in longer term gold prices.
The 10-year Treasury yields fell from 1.83% to 1.77% while traditional bond indices rose. Treasury yields fell on fears concerning global macroeconomic outlook. The 10-2 year yield spreads tightened for the second consecutive week, falling further from near three-month highs. Treasury yields will continue to be a focus as analysts watch for signs of a recession.
High-yield bonds dropped slightly over the week, defying traditional bonds and treasury movements as credit loosened. High-yield bond yields are likely to remain elevated in the long term as the Fed has taken a neutral monetary stance and investors pursue lower risk assets, likely driving yields higher over time.
Lesson to be Learned
It can be easy to become distracted from our long-term goals and chase returns when markets are volatile and uncertain. It is because of the allure of these distractions that having a plan and remaining disciplined is mission critical for long term success. Focusing on the long-run can help minimize the negative impact emotions can have on your portfolio and increase your chances for success over time.
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 27.68, 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
Investors will be watching to see if markets can resume the recent rally during the holiday shortened week after taking a breather.