Stocks were sharply negative, marking the largest weekly loss for major indices since March.
Global stock markets plunged on Wednesday and Thursday as investors fled riskier asset classes and flocked to safe-haven investments. Over the two-day period, major US stock indices dropped over 5%. While there did not seem to be a single cause for the sell-off, it appears rising interest rates weighed heavily on investor sentiment. Concerns that higher rates may stifle economic growth intensified as the 10-year Treasury Yield reached as high as 3.26% before finishing the week lower. With the sharp mid-week drop, the CBOE Volatility Index, a widely followed Index measuring the expected volatility of the S&P 500, spiked 43% higher.
However, it is important to keep the past week in perspective. Since the current bull market began in March 2009, there have been 26 separate occasions where markets have experienced a 5% or larger pullback, with five of these turning into 10% corrections. Furthermore, stock market volatility is more normal than unusual. Daily market drops of 2% or more are not uncommon, happening 76 total times since the beginning of this bull market (with nine such occurrences so far in 2018).
While the past week was unnerving, fundamental data remains mostly positive as corporate earnings are strong and the unemployment rate is at a multi-decade low. Interest rates are still relatively low by historical comparisons as well (the 10-year Treasury Yield is currently at 3.15% compared to the average of 6.20% since 1962), illustrating there could still be room for gradually rising rates before reaching a level that would halt economic expansion.
The prospects for the remainder of 2018 are still somewhat positive for global asset growth despite the past week, but many experts believe volatility will remain prevalent in upcoming months as trade negotiations are discussed further and interest rates continue to gradually rise. 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
The S&P 500 index dropped 4.1% last week, cutting the year-to-date gains almost in half. As the Index dropped below key 50,100, and 200-day moving averages, irrational behavior took over and worsened the sell-off. Although quick drops like this can sometimes be healthy for a continued bull market, the nature of the decline shed light that many investors have been overweight large-cap growth companies such as Apple, Microsoft, Amazon, and Alphabet. While this may prove to be a temporary market setback, it is a good opportunity to reevaluate and enhance the balance of assets within your portfolio.
*Chart source: Bloomberg
Broad equity markets finished the week negative as small-cap US stocks experienced the largest losses. S&P 500 sectors were negative, though defensive sectors held up stronger than cyclical sectors.
So far in 2018 technology, consumer discretionary, and healthcare are the strongest performers while materials and communication services have been the worst performing sectors.
Commodities were negative last week as oil prices decreased by 4.04%. This is the first decline in five sessions for crude oil, though the commodity is still trading near 4-year highs. Prices fell as the International Energy Agency (IEA) and OPEC nations trimmed their forecast for world demand this year and next. Analysts are specifically quoting current tensions between the US and China as hurting the global demand outlook. Going forward, investors are cautiously watching oil prices as Iranian sanctions are due to come into effect next month.
Gold prices increased by 1.41%, closing above $1,200/oz for the second time in the last six weeks. The weekly market rout led investors into gold as a safe haven asset, something we haven’t seen this year as treasuries dominated the safe space. However, with rapidly rising 10-year yields, investors found safety in the metal. Despite the recent rise in gold prices, it has yet to return to its beginning of the year levels.
The 10-year Treasury yield fell from 3.23% to 3.15%, resulting in a positive performance for traditional US bond asset classes. The fall in the 10-year treasury bond comes as a relief as the yield has increased nearly 18 basis points since the Fed rate hike. Although the rapid rise in rates rang some bells in the market, current yields are still far away from pre-financial crisis levels. Additionally, economic fundamentals remain strong and able to withhold higher rates. In the upcoming weeks, investors will be watching other economic indicators to gauge the direction of rates for the remainder of the year.
High-yield bonds were negative for the week as riskier asset classes dropped and the credit spread widened to 3-month highs. However, 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 commodities leading the way and international stocks lagging behind.
Lesson to be learned
You can’t predict the future, but you can prepare for it.”
– Howard Marks.
Nobody can predict exactly what is going to happen in the future. Nobody knows with 100% certainty when market tides are going to shift (see the dot-com bubble in 2000 or the financial crisis of 2008). However, sticking to a disciplined investment strategy and including a diverse basket of asset classes in your portfolio can help you increase the odds of success in the long-term, helping you better prepare for the uncertainty the future brings.
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 22.12, forecasting further economic growth and not warning of a recession at this time. The Bull/Bear indicator is currently 100% bullish – 0% neutral – 0% bearish. This means the indicator believes there is a slightly higher than average likelihood of stock market increases in the near term (within the next 18 months).