October 23, 2018 Weekly Market Update

October 23, 2018 Weekly Market Update

Global stocks were mixed during the week as third-quarter earnings helped provide support following the previous weeks’ sell-off.

Q3 earnings season is picking up steam as 17% of companies in the S&P 500 have reported results for the quarter. Of the companies that have reported, 80% have beaten earnings expectations. The blended quarterly earnings growth rate for the S&P 500 is now expected to be 19.5%. If this is the actual growth rate, it would be the third highest since Q1 2011 (only trailing behind Q1 and Q2 2018). Financials are largely responsible for the strong earnings so far as many large banks have much healthier balance sheets that what was in place prior to the 2008 crisis.

Despite strong earnings, concerns over rising interest rates kept a lid on gains. The release of the Federal Reserve minutes showed Fed officials remain convinced continuing to gradually increase interest rates is appropriate, despite President Trump’s criticism of the central bank’s actions. Policymakers also stated there might be a period where the Fed would even go beyond “normal” rates and into a more restrictive stance to control inflation from overshooting the long-term target. These details caused investors to worry higher interest rates could push corporate borrowing costs too high, leading to a slow-down in the economy.

However, it is important to keep things in perspective. Interest rates are still relatively low by historical comparisons (the 10-year Treasury Yield is currently at 3.20% 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 recent volatility, 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

Chinese markets continue to experience volatility as risks weigh on the country. Trade tensions, weakening economic growth, and poor performance are just a few of the reasons to name. Chinese stocks have lost 30% since their January high compared to an All-Country index which has lost just 8%. Furthermore, 60% of Shanghai Composite members are at 52- week lows – the highest level in seven years. Respectively, only 32% of S&P 500 companies sit at yearly lows. However, with several charts outlining troubling indicators, Chinese stock turnover remains low suggesting a possible rebound to come.

 

*Chart source: Bloomberg

 

Market Update

Equities

Broad equity markets finished the week mixed as large-cap US stocks experienced the gains while small-cap US stocks and international stocks experienced slight losses. S&P 500 sectors were mixed, with defensive sectors outperforming cyclical sectors.

So far in 2018 technology, health care and consumer discretionary are the strongest performers while materials and communication services have been the worst performing sectors.

 

Commodities

Commodities were negative as oil prices decreased by 3.11%. This is the second consecutive sharp decline for oil, though the commodity is still trading near 4-year highs. Prices fell as US stockpile reports increased to 6.5 million barrels – a fourth consecutive increase. Crude inventory also tripled analyst expectations, sending oil buyers running. Two-month futures on oil are trading at the biggest discount in a year as traders expect inventory to continue increasing. Investors are cautiously watching geopolitical events unfold in the coming weeks to better gauge how global demand may be affected.

Gold prices increased by 0.59%, closing above $1,200/oz for the third time in the last seven weeks. Although higher levels were reached during the week, rebounding equities sent the metal lower at week-end. Market volatility and increased geopolitical risk often lead investors into gold as a safe haven asset. However, a strong US dollar makes gold more expensive to purchase for foreign investors and can lead to price swings. Despite the recent rise in gold prices, it has yet to return to its beginning of the year levels.

Bonds

The 10-year Treasury yield rose from 3.15% to 3.20%, resulting in a negative performance for traditional US bond asset classes. The increase in the 10-year treasury yield follows the Federal Reserve’s comments indicating officials plan to proceed with raising rates as needed. Simultaneously, the 2-year Treasury yield rose to 2.92% – the highest since 2008. 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 remain volatile and credit spreads widened. 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

No portfolio guarantees success, but a plan never implemented is sure to fail.”

– Rick Ferri

You’re never going to be able to perfectly time market cycles in terms of adding or reducing risk in your portfolio. Even successful investing requires being uncomfortable and wrong much of the time. This is why having a plan in place is so imperative to long-term success. Sticking to a disciplined investment strategy and including a diverse basket of asset classes in your portfolio can help you prepare for the uncertainty the future brings and avoid making detrimental knee-jerk decisions at inopportune times.

 

Indicators

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).

 

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