Markets finish holiday-shortened week mixed as politics dominate headlines

Week in Review

I am happy to present this weeks market update written by FormulaFolio Investments.  U.S. stock markets finished the holiday-shortened week mixed as politics dominated headlines, resulting in a choppy week of trading. The week started on a negative note with political turmoil in Italy as President Sergio Mattarella refused to accept the finance minister proposed by a coalition government. Following the refusal, it appeared Italy was moving toward another election this year, with the potential to move heavily toward anti-eurozone policies. This sent Italian government bond yields sharply higher and US government bond yields sharply lower as demand for traditional safe-haven asset classes increased.  However, a different finance minister was approved later in the week, alleviating the immediate concerns in Italy.

As tensions in Italy eased, President Trump imposed the steel and aluminum tariffs on the European Union, Mexico, and Canada as the temporary exemption expired and trade talks remain gridlocked. Immediately following the announcement, European Commission President Jean-Claude Juncker said the EU will take “countermeasures” against the US. This added to the volatility for the week as investors speculated about the increasing potential for a trade war.

Despite the geopolitical uncertainties, markets ended the week on a positive note as the economy added 223,000 jobs, beating expectations of 185,000 jobs added. With strong job gains, the unemployment rate fell to 3.8% – its lowest level since April 2000. A lower unemployment rate is starting to put upward pressure on wage growth as average hourly earnings are 2.7% higher than a year ago.

While corporate earnings and economic data have remained mostly positive, many geopolitical risks remain present. Markets have been fickle since early February, and economic data and market sentiment can change quickly, which is why it is important to include a broad range of asset classes in your portfolio for more consistent and more stable longer-term results.

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

On Tuesday, the 10-year Treasury yield experienced its sharpest daily decline since the volatility spike in early February, falling to a low of 2.75%. However, yields rebounded back to 2.89% by the end of the week as investors became more confident about the prospects for further Fed rate hikes following the strong jobs report. Despite the recent drop in yields, the trend has been pointing mostly higher since mid-2016 (immediately following Brexit), though yields are still well off the recent high of 3.11% from May 17. Many experts believe the 10-year Treasury yield will end the year between 3.25% – 3.50% as the economy remains healthy and the Fed continues to gradually increase rates. This would represent a 12-21% increase from current levels.

*Chart created at StockCharts.com

Market Update

Equities

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

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

Commodities

Commodities were negative as oil prices fell 3.05%. This was the second consecutive weekly drop as US oil production has continued to rise. While the OPEC-led production cuts have largely supported a positive longer-term trend, Saudi Arabia and Russia have recently discussed boosting output, causing investors to fear a return to global over-supply.

Gold prices were negative with a 0.65% loss as higher Fed interest rate hike expectations pushed the metal lower. All things equal, higher US interest rates generally increase the value of the dollar, and a stronger dollar pushes gold prices down.

Bonds

The 10-year Treasury yield fell from 2.93% to 2.89%, resulting in positive performance for traditional US bond asset classes. Yields reached as low as 2.75% during the week as political tensions in Italy pushed investors toward more safe-haven asset classes. However, yields rebounded by week-end as the most recent jobs report showed US labor markets remain healthy, resulting in expectations for continued Fed rate hikes throughout 2018.

High-yield bonds were mostly flat for the week as rising credit spreads were offset by lower broad interest rates. 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 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

Geopolitical concerns have injected further volatility into markets in recent weeks, but the most recent jobs report illustrates the US economy remains mostly healthy. It will be important to see how markets react to the recent noise in a light week of economic data.

More to come soon.  Stay tuned.

Regards,

Phil Calandra

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Source: Phil Calandara