• Derek Prusa

5-Minute Market Update | February 20, 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 week positive as small-cap stocks experienced the largest gains. All S&P 500 sectors finished the week positive with cyclical sectors outperforming defensive sectors.

So far in 2018 consumer discretionary, technology, and financials are the strongest performers while real estate, energy, and utilities have been the worst performing sectors so far this year.

Commodities: Commodities were positive as oil prices rose 4.19%, breaking a two-week losing streak. Oil received support from a rebound in global stock markets and a weaker dollar, but the shorter-term upside is somewhat limited due to projections of rising US production. However, while US production is expected to rise for the foreseeable future, the OPEC production cuts have supported a longer-term positive trend.

Gold prices gained 3.08% – the strongest week since April 2016. Signs of inflation, along with a weaker dollar, have helped drive the metal higher this year.

Bonds: The 10-year treasury yield increased slightly from 2.83% to 2.87%, remaining near the highest level since the beginning of 2014. As yields remained mostly steady, aggregate US bonds were mostly flat amid continued speculation the Fed may hike rates faster than expected in 2018. Bond prices and interest rates move inversely, so higher rates generally lead to lower prices.

High-yield bonds were positive as riskier asset classes rebounded sharply following a sell-off during the previous week. If the economy remains healthy, higher-yielding bonds are expected to continue performing well as the risk of default is moderately low.

All equity asset class indices are currently positive in 2018 while bonds asset class indices are currently negative.

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.

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 21.35, 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 rebounded after finishing sharply negative for two consecutive weeks. 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) two weeks ago, but seemed to find support and has rallied off its lowest levels. This illustrates there may be support for a continued 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

Stocks had their best week since early 2013, moving back into positive territory for 2018.

Following the worst two weeks for the S&P 500 since August 2011, stocks rose sharply, recovering over half of the losses from the recent market sell-off. This rebound seemed to be largely driven by diminishing fears regarding a more aggressive monetary policy by the Fed. While investors shrugged off Fed fears, the Consumer Price Index (CPI) data released on Wednesday was higher than expected, showing inflation of 0.5% in January compared to the 0.3% estimate.

Investors embraced the strong inflation report this week as stocks ended Wednesday higher (which is interesting as the fear of higher inflation following strong wage growth data on February 2 is what initially sparked the recent correction). The support of inflation this time around shows the concerns earlier in the month may have been premature, as the Fed will likely not base its long-term policies on a single month of economic data. Rather, it takes time for the relationship of stronger wage growth and inflation to be reflected in the economy and flow through to more broad monetary policies.

Though shorter-term market momentum has been volatile and 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 shorter-term pullbacks can even be considered healthy for the continuation of a longer-term bull market.

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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