• Derek Prusa

5-Minute Market Update | April 2, 2018

I am happy to present this week’s market commentary from FormulaFolio Investments. The goal is to give our clients and friends a simple way to see everything they need to know about the financial markets on a weekly basis, in 5 minutes or less. After all, investing should be simple, not complicated.

Market Update

Equities: Broad equity markets finished the holiday-shortened week positive as large-cap US stocks experienced the largest gains. All S&P 500 sectors were positive for the week with defensive sectors outperforming cyclical sectors.

So far in 2018 technology and consumer discretionary are the only sectors with positive performance, while all other sectors are displaying negative performance year-to-date. Telecommunications, consumer staples, and energy have been the worst performing sectors so far this year.

Commodities: Commodities were negative as oil prices dropped 1.43%. Rising US production and a stronger dollar put pressure on oil prices during the week, but the longer-term trend remains positive as OPEC production cuts have supported prices since early 2016.

Gold prices were negative with a 2.09% loss as the dollar index increased for the fifth time in six weeks. While it was a negative week for gold, the metal is still positive in 2018 as the US dollar remains relatively weak and geopolitical uncertainties remain prevalent.

Bonds: The 10-year treasury yield fell from 2.82% to 2.74%, resulting in positive performance for traditional US bond asset classes. Yields had been trending higher in 2018, but despite the Fed hiking rates 0.25% following the March 21 meeting to a range of 1.50 – 1.75%, longer-term bond yields have fallen as demand for treasuries as a safe-haven asset class has increased in recent weeks.

High-yield bonds were positive for the week as riskier asset classes performed well. If 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.

All asset class indices, with the exception of commodities, are currently negative in 2018.

Lesson to be learned: “Bottoms in the investment world don’t end with four-year lows; they end with 10- or 15-year lows.” – Jim Rogers. Short-term market corrections can be unnerving, but they are an inevitable part of investing and are often short-lived in relation to a longer-term bull market trend. However, there are certain times where these market corrections can turn into a prolonged bear market (such as 2008). This is why it is important to maintain a disciplined investment strategy focused on longer-term market tendencies rather than focusing on the daily market noise.

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 21.12, forecasting further economic growth and not warning of a recession at this time. The Bull/Bear indicator is currently 100% 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).

Weekly Comments & Charts

The S&P 500 finished the week positive, though equity markets remain choppy. While shorter-term momentum has pushed the S&P 500 lower, longer-term momentum remains intact as the Index is still within the trading range that has been in place over the past two years. The Index has tested the lower bounds of this trading range (which is inline with the 200-day simple moving average) in recent weeks, but has found support both times, indicating there may be a continuation of the longer-term bull market despite the shorter-term weakness. However, if the Index falls below this support threshold, it could result in further downward pressure as markets fall into a more bearish posture. 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

Q1 comes to a close as volatility returns to the markets.

The first quarter of 2018 has officially come to a close and one thing is certain: it is not 2017 anymore. While 2017 was one of the quietest years in history for broad stock markets (the S&P 500 set a record for the least severe drawdown in a calendar year ever), volatility has returned to the markets in 2018. So far in 2018 stocks have advanced or declined by more than 2% in nine of the first 13 weeks, with no such weeks in all of 2017. Furthermore, the CBOE Volatility Index (VIX), which measures the stock markets expectation for volatility based on options trading of the S&P 500 Index, has closed above 15 in eight weeks this year, compared to closing above 15 in only two weeks last year.

As market sentiment has continued to swing wildly between optimism and pessimism, market fundamentals have remained mostly positive. The most recent earnings season (Q4 2017, which was reported throughout the first quarter of this year) was the strongest quarter of corporate growth since Q3 2011, as the blended earnings growth rate for the S&P 500 was 14.8%. For the upcoming earnings season beginning in April, the estimated earnings growth rate is even higher at 17.3%. The labor market has also continued to soar in 2018 as employers added over 200,000 jobs in both January and February.

While the first quarter of the year has been volatile, and at times emotionally draining, it is important to stay focused on the bigger picture. Even with all of the recent volatility and downward pressure, most indices (including bonds) are down only about 1 – 2% year-to-date. This snaps a string of nine consecutive positive quarters for the S&P 500 and Dow Jones Industrial Average, but in reality the losses were somewhat minimal compared to how 2018 has felt.

Even in the strongest of bull markets, stocks will not rise every day / week / month / quarter, and periodic pullbacks should be expected. These pullbacks can even be considered healthy for the continuation of a longer-term bull market. Higher levels of volatility can be expected during short-term market corrections, but the longer-term prospects of 2018 remain mostly positive as corporate earnings and economic fundamentals remain strong.

Short-term market corrections are only a small blip on the radar for long-term investors. However, economic data and market sentiment can change quickly. This is why it is still important to include a broad range of asset classes in your portfolio for more consistent and more stable longer-term results, rather than chasing short-term returns.

As investors, we need to stay committed to our long-term financial goals. All the short-term news and market movements can be the most debilitating of all when it comes to making sound investment decisions; especially if we allow them to influence knee-jerk decisions.

More to come soon.  Stay tuned.


Derek Prusa, CFA, CFP® Senior Market Analyst

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