Stocks Yo-Yo: Trend Still Down

Stocks Yo-Yo: Trend Still Down

Monthly Outlook: February 2019

Wow, what a great month for stocks! Markets yo-yoed in December and January. You may remember 2018 ended on an unhappy note with stocks dropping sharply in December. U.S. stocks (S&P500) dropped 8.8% in December. But then they snapped back 7.9% in January! The same yo-yo pattern occurred in international stocks with the EAFE Index dropping 5.3% in December and snapping back 6.6% in January. The news will highlight the recent strength but really stock markets are only back to where they were two months ago at best. As always, we use our long-term trend indicator (using the 200-day moving average) to determine the overall trend of each market. And unfortunately, nearly every stock market remains in a down-trend for now. Sorry to be the bearer of that news. Of course, the bounce in January puts most stock markets closer to their declining trend line, but we can’t call a trend reversal to “up” quite yet. For that reason, we remain under-weighted most stock markets. On a bright note, Emerging Markets did manage to turn up on the last day of January so we have added back our full allocation there. Might a trade deal be near?

Bonds got in on the upswing in January, too. The Barclay’s Aggregate Bond Index (mid-term investment grade bonds) had a nice bounce in January gaining 1.1%, following a 1.8% gain in December. Bonds, unlike stocks, are in an up-trend so we’re fully invested within our iFolios allocation models. Although the Federal Reserve bankers continue to slowly raise the Fed Funds rate (overnight rate between banks), the rate that really drives lending, the 10-year US Treasury rate, continues to decline from its recent peak in October of 3.2% to 2.6% today.

We’ve Seen this Pattern Before

So, stocks are very volatile these past few months, tracing out a yo-yo pattern with significant losses and then gains. Unlike the rare deep freeze and thaw of the Upper Midwest this week, the stock market yo-yo is fairly common. Looking at the S&P500 chart for the past 20 years, we can see numerous examples of the current pattern (breaking below the 200-day moving average with a plunge of -15%+ and a subsequent rally of at least 10%). We saw it in 2008, 2011, and 2015. By now you should be anxiously asking, “So what happened next in those examples?” In 2008, the stock market went on to lose 50%. But in 2011 and 2015, the rebound continued and an uptrend resumed allowing the markets to trend higher for multiple years. We’re at a tipping point here and will know the answer to how this pattern plays out within a month or two. Either the January rebound will fail and we’ll be glad that we’re already very under-weighted stocks or the rebound will continue into February and we’ll need to buy back stocks and re-join the growth party. Either way, being “out” of stocks these past few months hasn’t hurt us at all and we’ve had a less volatile ride as a result. Stay tuned as we’ll surely have more to say next month!

What We’re Watching

Of course, the most critical thing we watch is the actual price trend of every holding in our portfolios. But we keep a close eye on various other indicators that might affect those price trends. The Unemployment Rate is currently 3.9% and has fallen steadily since 2010 when it peaked at 10.0%. That’s great at first blush, but the rate might be as good as it’s going to get this cycle. If it rises to 4.0% in the next month or two, that would be enough to reverse the trend and could hurt stocks. The Conference Board’s Leading Economic Indicator (LEI) is near an eight- year high but it has now dropped for the past three months from its peak. The Case Shiller Home Price Index (another major financial asset) is still very strong but it, too, has been softening for the past several weeks. Last week, Federal Reserve Chair Powell announced that due to their outlook of a strong, but possibly peaking, economy that they would move more slowly to raise interest rates further. The data and facts are strongly hinting that while business and the economy seem generally strong, the long eight-year recovery may be finally slowing down. Will it slow enough to turn to a recession and/or bear market? Or will the Federal Reserve pull out some magic monetary policy again to push stocks higher? We’re going to find out soon and we’ll invest accordingly.