• Derek Prusa

5-Minute Market Update | January 23, 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 large-cap US stocks experienced the largest gains. S&P 500 sectors finished the week mixed as there was no discernable difference in the performance between cyclical sectors and defensive sectors.

So far in 2018 consumer discretionary, healthcare, and technology are the strongest performers while utilities, real estate, and telecommunications are the only sectors with negative performance year-to-date.

Commodities: Commodities were negative for the first time in five weeks as oil prices fell 1.45%. While the OPEC-led output cuts have been supporting oil in recent weeks, the International Energy Agency warned rapidly increasing production in the United States could threaten market balancing, pushing prices slightly lower.

Gold prices fell 0.13%, snapping a streak of five consecutive weeks of gains for the metal.

Bonds: The 10-year treasury yield rose from 2.55% to 2.64%, resulting in negative performance for treasury and aggregate bonds. Yields have continued to trend higher recently on expectations that the Fed may hike rates faster than originally anticipated amid stronger economic growth and fiscal stimulus in 2018.

High-yield bonds were mostly flat as the negative impact of higher interest rates was largely offset by the positive performance in riskier asset classes. If the economy remains strong and healthy, higher-yielding bonds are expected to continue outperforming aggregate bonds as they offer higher interest payments and the risk of default is moderately low.

All riskier asset class indices are currently positive in 2018, but treasury and US aggregate bonds are currently negative.

Lesson to be learned: “The stock market is the story of cycles and of the human behavior that is responsible for overreactions in both directions.” – Seth Klarman. Markets tend to move in broad cycles. However, when crisis seems to strike (or even when things appear too good to be true), a herd mentality can form as investors copy the behavior of others because they are influenced to act and think in a certain way. By maintaining a broadly diversified blend of asset classes and eliminating emotions from the investment process when making decisions, you can look to take advantage of the major trends caused from the herd mentality, improving your probability of long-term success.

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 19.28, 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 eighth time in nine weeks as the Index has started 2018 on a strong note and remains firmly in the upward trend that began in mid-February 2016. Since February 12, 2016, the S&P 500 is up 53.65%. Shorter-term momentum has continued as the Index recorded fresh all-time highs and remained above the upper trading range that has been in place over the past two years, illustrating there may still be further gains ahead. Stock markets are still in a historically low risk and volatility environment as there has not been a 5%+ correction for the S&P 500 in 394 trading days – the third longest streak in the history of the Index. 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 bullish pattern for now.

*Chart created at StockCharts.com

US stocks logged another positive week in spite of rising concerns surrounding a government shutdown.

As of Friday afternoon, the Senate had failed to pass a new budget deal. Without a deal in place the government shuts down and many federal employees stop receiving their paychecks until a new funding deal is reached. The last time this happened was in 2013, where approximately 800,000 federal employees were furloughed between October 1 – October 17. Though the true impact of a government shutdown depends on the unique scenario in which it happens, historically, for each week a deal is not reached it reduces GDP by 0.20% for the quarter in which the shutdown occurred.

However, once the government re-opens, federal workers receive back pay for the time they missed—meaning that GDP growth typically rebounds in the following quarter. Due to this typical rebound, financial markets tend to shrug off the anxieties of a shutdown, treating the news as normal market noise and not something that will shift the fundamentals of the underlying economy in the long-term. This mindset, coupled with another strong week of earnings reports helped push equity markets higher, even in the face of the growing negative press at the end of the week.

*As of Monday evening president Trump signed a bill to fund the government through February 8.

Though the prospects of 2018 appear positive as we start the year, 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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