November 13, 2018 Market Update
Markets rallied as US midterm elections went mostly as expected, with Democrats winning control of the House of Representatives and Republicans holding majority in the Senate.
Though the election resulted in a split Congress, increasing the potential for political gridlock moving forward, markets rallied on the outcome. The reason? A split government will likely leave in place many of the policies the Trump administration has already passed through while keeping the President in check on some of his more “extreme” actions, such as increasing tariffs. Furthermore, Republicans and Democrats have mutually been supportive of improving infrastructure and reducing drug prices, both of which could provide economic benefits.
With midterm elections in the rearview mirror, what lies ahead for US stock markets? Since 1946 there have been 18 midterm elections. Leading up to these midterms, US stocks have typically performed poorly (from the January through October just prior, US stocks dropped an average of 1%). However, in the one-year period immediately following these elections, the S&P 500 has been positive every single time with an average gain of 17%. While history doesn’t predict the future, a cloud of uncertainty has been lifted, which could provide support for markets as investors regain confidence.
As political uncertainties pass by, investors will have a greater ability to focus on the long-term fundamental drivers of broad markets. With the labor market and corporate earnings remaining strong, and a generally optimistic seasonal period (boosted by strong holiday sales) just ahead, the prospects for the remainder of 2018 are still somewhat positive for global asset growth despite recent volatility.
While US stocks have outperformed most other investment alternatives so far this year, it is important to remember to include a broad range of asset classes in your portfolio. While short-term trends and market noise can make it tempting to make knee-jerk decisions, as investors we need to stay committed to our long-term financial goals. 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
Short-term volatility can be scary, which is why it is important to observe returns and market behavior over a stretch of time. Within the last 30 years, the S&P 500 only experienced negative Q4 returns a hand full of times. A few of these instances were directly related to a more significant market crash (dotcom bubble & financial crisis of ‘08). Additionally, within both those times market observers note losses were magnified when investors traded emotionally to avert further losses. Traders observe that the US benchmark stock gauge usually rallies in Q4 and following midterm elections. Additionally, some research points that the third year under a Republican president tends to be the best year for stock markets. Although we don’t base decisions off these observations, historical trends coupled with the current strong fundamental data point to the potential for a market rebound and year-end rally. However, as upcoming geopolitical events unfold, investors should brace for higher than average volatility and make sure to stick to their proposed plans.
*Chart source: Bloomberg
Broad equity markets finished the week positive as large-cap US stocks experienced the largest gains. S&P 500 sectors were mostly positive, with defensive sectors outperforming cyclical sectors.
So far in 2018 healthcare, consumer discretionary, and technology are the strongest performers while materials and communication services have been the worst performing sectors.
Commodities were negative as oil prices decreased by 4.67%. This is the second largest weekly decline since May as oil prices have now experienced ten consecutive daily declines. The most recent decline put oil into an official bear market as investors roil to find a support level. Sanctions on Iran seem to not have affected the market as perceived as waivers were granted to a group of countries. Additionally, supply levels remain high as the US is now pumping more oil than Russia and Saudi Arabia. U.S. oil production jumped to a high of 11.6 million barrels a day last week and is up 2 million barrels a day on a year-over-year basis.
Gold prices fell by 1.99%, closing the week at $1206.40/oz. The metal dipped to a 1-month low as the Federal Open Market Committee kept rates steady but stood by their decision to continue gradually raising rates. The probability for a rate hike in December is now 75.8%. As investors are aware, higher interest rates make the US dollar stronger, ultimately deterring investors from gold. Since gold is US dollar denominated, a stronger dollar makes it more expensive for foreign investors to purchase the metal. Additionally, the recent stock market rout seems to have settled, restoring sense of stability where equities could appear favorable once again. For gold prices to rise, supply levels would have to decrease or the dollar would need to weaken from current levels.
The 10-year Treasury yield fell from 3.22% to 3.19%, resulting in positive performance for traditional US bond asset classes. The decrease in the 10-year treasury bond came as volatility somewhat settled from the previous week. Additionally, jobless claims and consumer sentiment met analyst expectations, providing safety in the market. Strong economic data continues to support the Fed’s decision to hike rates, pressuring treasury yields. In the upcoming weeks, investors will be watching geopolitical and market events in order to gauge the need for safe haven treasuries.
High-yield bonds were positive for the week as riskier asset classes rebounded and credit spreads tightened. As long as the economy remains healthy, higher-yielding bonds are expected to continue outperforming traditional bonds in the long-run as the risk of default is moderately low.
Asset class indices are mixed so far in 2018, with large-cap US stocks leading the way and international stocks lagging behind.
Lesson to be learned
In the short run, the market is a voting machine. In the long run, it is a weighing machine.”
– Benjamin Graham
Markets can behave like a popularity contest in the short-term as prices and trends can change quickly based on speculation and noise. However, in the long-term, market prices tend to reflect fundamentals. This is why having a concrete plan in place is so imperative. Sticking to a disciplined investment strategy can help take emotions out of the investment process and improve your chances for long-term success.
Our investment team 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 24.63, forecasting further economic growth and not warning of a recession at this time. The Bull/Bear indicator is currently 33.33% bullish – 33.33% neutral – 33.33% bearish. This means there is no clear direction of stock market movements for the near term (within the next 18 months).