Strong earnings push stocks higher despite rising interest rates
Week in Review
Global equity markets were positive for the week as stronger-than-expected earnings reports and solid economic data supported gains. The strong start to Q1 earnings season was a welcome distraction from the recent whirlwind of geopolitical uncertainties, with the six largest US banks reporting growth of 24% compared to the 17% expectation.
While it was a positive week for stocks, gains were kept in check as interest rates climbed higher. After starting the year at 2.46%, the 10-year treasury yield flirted with the psychological 3% level, ending the week at 2.96%. Though a yield above 3% would not be discernibly different than the current 2.96%, there is a psychological aspect that could make investors anxious about seeing these levels.
Since the early 1980s, interest rates have been in a steady downward trend. A clean break above 3% may confirm we are in an official “rising rate” environment for the first time in over three decades, which could reignite fears that rates will continue to rise into the near future. Higher rates are generally a headwind to economic growth as they result in higher costs when borrowing money, and thus lower spending and economic activity. However, it is important to realize interest rates are still historically low on a relative basis despite the recent move higher (the 10-year treasury yield was above 15% when rates peaked in 1981).
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 reduce daily market noise and increase the odds of a successful outcome over time.
Chart of the week
The S&P 500 finished the week positive, but continued to trade within the triangle pattern that developed in early February. As illustrated in the chart below, the Index has been consolidating in recent weeks, reaching lower highs and higher lows. Generally, with these triangle patterns, markets continue to consolidate until there is a fresh breakout. If markets breakout above the upper trend line, it can indicate the start of a new bullish trend. However, if markets fall through the lower trend line, it can mark the start of a bearish trend. While shorter-term momentum has been volatile and inconclusive, longer-term momentum remains intact as the Index has held above the lower-bounds of the positive trend that began in early 2016. Due to the continued support near this level, there may be a continuation of the longer-term bull market despite the shorter-term weakness. The coming weeks should continue to provide valuable insight about the near-term direction of the S&P 500, but it seems to remain in a long-term bullish pattern for now.
*Chart created at StockCharts.com
Broad equity markets finished the week positive as small-cap US stocks experienced the largest gains. S&P 500 sectors were mixed with cyclical sectors outperforming defensive sectors.
So far in 2018 technology, consumer discretionary, and energy are the only sectors with positive performance, while all other sectors are displaying negative performance year-to-date. Consumer staples, telecommunications, and real estate have been the worst performing sectors so far this year.
Commodities were positive as oil prices rose 1.47%. Oil prices reached a fresh three-year high during the week as strong demand resulted in a surprise drawdown in inventories. Along with increasing demand, OPEC-led production cuts and geopolitical tensions in Syria have supported prices in recent weeks.
Gold prices were negative with a 0.71% loss as the dollar index gained on rising interest rates and inflation expectations. While it was a negative week, a relatively weaker dollar combined with geopolitical uncertainties has resulted in slightly positive performance for the metal so far this year.
The 10-year treasury yield increased sharply from 2.82% to 2.96%, resulting in negative performance for traditional US bond asset classes. Yields reached their highest levels since January 2014, largely driven by solid economic data and expectations of higher inflation, but remain relatively low on a historical basis.
High-yield bonds were also negative for the week as the increase in broad interest rates offset the positive impact of riskier asset gains. 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 traditional bond categories lagging behind.
Lesson to be learned:
“The investor’s chief problem – and even his worst enemy – is likely to be himself.”
– Benjamin Graham.
People are emotional, and possess many biases when it comes to investing. A couple examples of these biases include hindsight (looking back and thinking it was easy to predict how things actually played out) and illusion of control (the tendency for people to overestimate their ability to control events they cannot actually influence). Unfortunately, these biases make us more susceptible to short-term market noise and poor investment decision making. This is why it is important to maintain a disciplined, emotion-free, investment strategy.
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 21.60, forecasting further economic growth and not warning of a recession at this time. The Bull/Bear indicator is currently 83% bullish. This means our models believe there is a slightly higher than average likelihood of stock market increases in the near term (within the next 18 months).
The Week Ahead
While Q1 2018 earnings season is officially underway, more than one-third of companies in the S&P 500 report results in the upcoming week (including companies such as Microsoft, Google, Facebook, and Amazon), making this an important week of data releases. The first estimate of Q1 GDP will also be released on Friday, which should provide a better picture of total economic strength.
More to come soon. Stay tuned.
Source: Phil Calandara