Escalating trade tensions send broad equity markets lower

Week in Review

Equity markets were mostly negative for the week as trade tensions continued to intensify. Following China announcing it may retaliate with tariffs on US exports, President Trump announced the administration would look into higher tariffs on an additional $200 billion in Chinese imports. The back-and-forth dialogue between the US and China has raised some investors’ concerns about slowing global growth and higher than expected inflation.

Despite the recent escalation, big-name investors such as Warren Buffett, Paul Tudor Jones, and Lloyd Blankfein believe the current worries are somewhat overplayed. These successful investors largely believe this is part of a negotiating pattern and the US will eventually reach deals with other countries before any trade conflicts become too serious. Nonetheless, it is widely agreed these trade negotiations will continue to make headlines in upcoming weeks, resulting in heightened market volatility in the near-term.

While there are still many uncertainties surrounding global trade activity, market fundamentals remain mostly healthy. Corporate earnings are coming off their strongest quarter since 2010 and Real GDP is expected to come in around 4% for Q2 – a growth rate recently though unattainable.

Markets have been volatile since early February, highlighting the importance of remaining invested in a risk-appropriate, broadly diversified portfolio. The day-to-day noise can tempt even the most intelligent investors to make knee-jerk decisions. However, 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.

We are currently in the second longest period in history in which large-cap growth stocks have outperformed large-cap value stocks. Measured by rolling 10-year returns, growth stocks have outperformed their value counterpart for 54 months (the longest such streak in history was 57 months from 1996 – 2000). While this trend has been persistent in recent years, history points to value stocks bouncing back. Historically, whenever growth has outperformed value by over 2% in a 10- year period, the next three years show value outperforming growth by 7.3%. The chart below shows the Russell 3000 Value Index (red line) and the Russell 3000 Growth Index (blue line) immediately following the 2008 financial crisis, with a clear divergence starting in mid-2014.

*Chart created at StockCharts.com

Market Update

Equities

Broad equity markets finished the week mostly negative as large-cap US stocks experienced the largest losses and small-cap US stocks were mostly flat. S&P 500 sectors were mixed with defensive sectors broadly outperforming cyclical sectors.

So far in 2018 consumer discretionary, technology, and energy are the strongest performers while telecommunications, consumer staples, and industrials have been the worst performing sectors.

Commodities

Commodities were positive as oil prices jumped 5.41% – snapping a four-week losing streak. Oil prices surged on Friday as OPEC agreed to increase output by up to 1 million barrels per day, though many experts believe the real increase will only be around 700 thousand. While higher output generally pushes prices lower, the agreed increase was lower than expected (at one point, investors expected an increase of up to 1.8 million barrels per day). The OPEC-led production cuts have supported a positive longer-term trend, so the lower than expected production increase provided a relief to investors.

Gold prices were negative with a 0.56% loss. A generally stronger dollar has resulted in downward pressure for gold in recent months, but the metal has also been somewhat supported by geopolitical concerns, helping provide support from further downside risk.

Bonds

The 10-year Treasury yield fell from 2.93% to 2.90%, resulting in slightly positive performance for traditional US bond asset classes. Despite the recent Fed rate hike, yields have remained suppressed in recent weeks as trade war fears have caused investors to shift toward more safe-haven asset classes.

High-yield bonds were negative for the week as riskier asset classes experienced downward pressure. 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 small-cap US stocks leading the way and traditional bond categories lagging behind.

Lesson to be learned

All you need for a lifetime of successful investing is a few big winners, and the pluses from those will overwhelm the minuses from the stocks that don’t work out.”

– Peter Lynch.

Nobody likes to lose money, but losses are an inevitable part of investing. The key is to control your losses and manage downside risk intelligently, so you are in the best position possible to take advantage of larger market upswings. By sticking to an emotion-free, disciplined investment strategy, you can increase the odds of success in the long-term by determining when it is most appropriate to take risk and when it is more appropriate to hedge risk.

FFI Indicators

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 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 23.07, forecasting further economic growth and not warning of a recession at this time. The Bull/Bear indicator is currently 50% bullish – 50% bearish. This means the indicator has a neutral outlook on stock market direction in the near term (within the next 18 months).

The Week Ahead

Consumer spending and consumer sentiment data will be released on Friday. Investors will be eyeing these reports to see how consumers have been reacting to the recent increase in global trade tensions.

More to come soon.  Stay tuned.

Regards,

Phil Calandra

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Source: Phil Calandara