• Derek Prusa

5-Minute Market Update | January 29, 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. All S&P 500 sectors finished the week positive as cyclical sectors slightly outperformed defensive sectors.

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

Commodities: Commodities were positive as oil prices increased 4.37%. US crude oil prices reached $65 a barrel for the first time since December 2014, setting a new 3-year high following the 10th consecutive weekly drop in US inventories.

Gold prices rose 1.43% as the dollar continued to slide. A weaker dollar makes dollar-denominated assets, such as gold, less expensive for holders of other currencies, pushing prices higher.

Bonds: The 10-year treasury yield rose slightly from 2.64% to 2.66%, resulting in mostly flat 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 positive as riskier asset classes performed well and credit spreads fell during the week. 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 ninth time in ten 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 57.07%. 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 399 trading days – the 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

Stocks continued to soar, and the S&P 500 is trading in a way it hasn’t seen in decades.

Through the end of last week, the S&P 500 has closed at a record-high 14 times since the beginning of the new year, marking the most records in any month since June 1955. Furthermore, the 7.45% gain so far in January has put the S&P 500 on track for its strongest first month since 1989. There have been 13 years where the S&P 500 has risen by more than 5% in January – in those years, the Index has averaged an additional 11% gain for remainder of the year and has never finished the year negative (though this does not guarantee gains through the remainder of 2018).

While some economists may attribute this recent performance to the “January effect”, which is the hypothesis that stock prices increase more in January than any other individual month, the strong start to 2018 seems to have supportive data behind it. January’s gains reflect recent positive economic conditions and encouraging corporate earnings announcements, which are in part benefiting from the optimism around tax reform. With strong employment, the prospects of rising wages, high consumer confidence, a healthy housing market, and strong corporate earnings, the broad economy looks healthy. However, it would not be unreasonable to expect higher volatility and downside risk than what has been experienced in the past couple years.

Though the prospects of 2018 remain 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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