5-Minute Market Update | February 12, 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.
Equities: Broad equity markets finished the week negative as international stocks experienced the largest losses. All S&P 500 sectors finished the week negative as cyclical sectors underperformed defensive sectors.
So far in 2018 consumer discretionary is the only sector with positive performance, while all other sectors are displaying negative performance year-to-date. Utilities, energy, and real estate have been the worst performing sectors so far this year.
Commodities: Commodities were negative as oil prices fell 9.55%. This was the worst week in two years for oil as rising production, a stronger dollar, and the broad financial asset sell-off combined to weigh down prices. Though there was a sharp decline in oil prices for the week, prices remain higher than previous years as OPEC production cuts have supported a longer-term positive trend.
Gold prices dropped 1.62% as the dollar continued to firm. A stronger dollar makes dollar-denominated assets, such as gold, more expensive for holders of other currencies, pushing prices lower.
Bonds: The 10-year treasury yield fell slightly from 2.84% to 2.83%, remaining near the highest level since the beginning of 2014. Though yields remained mostly steady, aggregate US bonds were still negative as there is speculation that the Fed may hike rates faster than expected in 2018. Bond prices and interest rates move inversely, so higher rates generally leads to lower prices.
High-yield bonds were negative as riskier asset classes wavered. However, if the economy remains healthy, higher-yielding bonds are expected to continue performing well as the risk of default is moderately low.
All asset class indices are currently negative in 2018.
Lesson to be learned: “If you have trouble imagining a 20% loss in the stock market, you shouldn’t be in stocks.” – John Bogle, founder of Vanguard. As frustrating as it can be at times, the stock market has its ups and downs. The risks of investing in stocks goes hand-in-hand with the higher return potential compared to safer investments such as bonds or bank CDs. While it may be tempting make knee-jerk decisions when markets move quickly, we need to stay focused on our long-term investment objectives. Keeping a disciplined investment strategy can reduce daily market noise and increase the odds of a successful outcome over time.
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 21.35, 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 sharply negative for the second consecutive week. While shorter-term momentum has pushed the Index lower, longer-term momentum remains intact as the Index remains in the trading range that has been in place over the past two years. The index tested the lower bounds of this trading range (which is inline with the 200-day simple moving average), but seemed to find support and rallied to end the week off its lowest levels. This illustrates there may be support for a continued longer-term bull market despite the shorter-term weakness. Stock markets are no longer in a historically low risk and volatility environment as the S&P 500 experienced its first 5% pullback in over 400 trading days – which was the longest streak in the history of the Index without such a pullback. 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
US stocks officially reached correction territory as major indices faltered for a second consecutive week.
On Thursday, the S&P 500 closed 10.16% lower than its recent January all-time-high level, pushing the Index into correction territory (a market correction is considered a price decline of 10% or more). This is the largest decline since early 2016, when the S&P 500 got off to the worst start of a calendar year in history (though the Index finished 2016 up 11.96%). Volatility has already been more of a factor this year than it had been in all of 2017 as the S&P 500 Volatility Index (VIX) has more than doubled since January 31.
With US stocks officially in a correction, what lies ahead for the markets? While it impossible to know, history shows there may be a rebound on the horizon as less than 20% of corrections turn into a more pronounced bear market (a price decline of 20% or more). However, even if this is just a normal shorter-term market correction, there could still be high levels of volatility and further downside risk in the coming weeks. The average bull market correction is about 13% and takes approximately four months to recover back to new all-time-highs.
While the last couple of weeks have been ugly (this was the quickest 10% drop from an all-time-high since 1928), it is important to keep things in perspective. A correction in the US stock market happens approximately once every year, but the velocity of the recent drop following a historically low-volatility 2017 has many investors feeling more anxious than normal. Despite the recent downturn, the S&P 500 is still up 43.22% since February 12, 2016 (the low point of the last correction) – illustrating a strong longer-term trend remains intact.
The start of this recent downturn was sparked by a piece of good news as the most recent jobs report illustrated strong wage growth, causing investors to worry the Fed may be more aggressive than originally expected with rate hikes this year. The subsequent sharp downward movements seemed to be a mixture of investors taking profits after a strong two-year run and volatility-based quant strategies getting caught off-guard and forced to close positions quickly. Though shorter-term market momentum has turned abruptly negative, the longer-term prospects of 2018 remain mostly positive as corporate earnings and economic fundamentals remain strong.
Even in the strongest of bull markets, stocks will not rise every day / week / month, and periodic pullbacks should be expected. These pullbacks can even be considered healthy for the continuation of a longer-term bull market.
These 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