• Derek Prusa

5-Minute Market Update | February 26, 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 mostly positive as large-cap US stocks experienced the largest gains and international stocks experienced small losses. S&P 500 sectors were mixed for the week with cyclical sectors outperforming defensive sectors.

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

Commodities: Commodities were positive as oil prices rose 3.03%. This was the second consecutive strong week for oil as a dip in Libyan production and positive comments from Saudi Arabia regarding the OPEC production cuts helped push prices higher. While US production is expected to rise for the foreseeable future, which could cap gains in oil, the OPEC production cuts have supported a longer-term positive trend.

Gold prices fell 1.91% for the week as the dollar strengthened. While this was the worst week for gold since early December, the metal is still positive in 2018 as the US dollar remains relatively weak.

Bonds: The 10-year treasury yield increased slightly from 2.87% to 2.88%, 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 mostly flat for the week as credit spreads remained stable. 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 finished positive for the second consecutive week immediately following its first 10% correction since early 2016. 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) three 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

US stocks pushed modestly higher as volatility persisted through the holiday-shortened week.

After essentially moving only up and to the right in 2017, stocks have been much more volatile this year. Though volatility has somewhat subsided since its rapid spike higher in early February, markets have continued to swing up and down. Last week saw this to a smaller extent as the S&P 500 was down over 1% by mid-week before rallying to end the week with modest gains. The average daily price movement for the Index in February has been 1.3%, compared to an average daily movement of 0.3% for all of 2017. While intra-week volatility was still present, this week broke the wild ride in which the S&P 500 experienced its worst week in two years directly followed by its best week in five years.

Many investors expect this higher volatility environment to persist in the near-term as market participants continue to speculate about economic growth and interest rates. Rates have been moving higher recently for the same reason the stock market had been rising (a strong economy), and the fear of higher rates removing momentum from the bull market is what sparked the recent market correction and higher levels of volatility in the first place.

However, it is important to remember interest rates are still historically low. While the 10-year treasury yield has sharply increased from 2.05% to 2.88% since early September, this is not as severe as the move from 1.66% to 3.04% back in 2013 – and that move did not kill the bull market as stocks have continued higher, though not without a few short-term corrections along the way. The Fed is expected to raise rates three times in 2018, but considering the relatively low level of current rates, this should be considered more like letting the foot off the accelerator rather than slamming the brakes on the markets and economy.

Though shorter-term market momentum has been volatile and somewhat 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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