• Derek Prusa

5-Minute Market Update | March 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 sharply negative as large-cap US stocks experienced the largest losses. All S&P 500 sectors were negative for the week with cyclical sectors underperforming defensive sectors.

So far in 2018 technology and consumer discretionary are the only sectors with positive performance, while all other sectors are displaying negative performance year-to-date. Telecommunications, consumer staples, and real estate have been the worst performing sectors so far this year.

Commodities: Commodities were positive as oil prices rose 5.68%. Oil prices surged on Friday after the Saudi Arabia energy minister said OPEC, as well as non-OPEC countries such as Russia, may need to extend the current production cuts into 2019. The longer-term trend of oil prices has been positive since early-2016, largely supported by these OPEC-led production cuts.

Gold prices were positive with a 2.87% gain as the dollar index fell for the first time in five weeks. The metal was largely supported by fear of a global trade war, sending investors toward more safe-haven asset classes.

Bonds: The 10-year treasury yield fell slightly from 2.85% to 2.82%, resulting in somewhat flat performance for traditional US bond asset classes. Yields had been trending higher in 2018, but despite the Fed hiking rates 0.25% following the March 21 meeting to a range of 1.50 – 1.75%, longer-term bond yields fell as demand for treasuries as a safe-haven asset class increased.

High-yield bonds were negative for the week as broad riskier asset classes experienced downward pressure, offsetting the positive impact of lower interest rates. However, if the economy remains healthy, higher-yielding bonds are expected to continue outperforming traditional bonds longer-term as the risk of default is moderately low.

All asset class indices, with the exception of commodities, are currently negative in 2018.

Lesson to be learned: “Bottoms in the investment world don’t end with four-year lows; they end with 10- or 15-year lows.” – Jim Rogers. Short-term market corrections can be unnerving, but they are an inevitable part of investing and are often short-lived in relation to a longer-term bull market trend. However, there are certain times where these market corrections can turn into a prolonged bear market (such as 2008). This is why it is important to maintain a disciplined investment strategy focused on longer-term market tendencies rather than focusing on the daily market noise.

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 21.12, 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 the week sharply negative as equity markets remain choppy. While shorter-term momentum has pushed the S&P 500 lower, longer-term momentum remains intact as the Index is still within the trading range that has been in place over the past two years. The Index is currently re-testing the lower bounds of this trading range (which is inline with the 200-day simple moving average) similarly to early February. However, if the Index is able to find additional support at this level, it may illustrate a continuation of the 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

Broad equity markets moved sharply lower on the week as investors fear global trade war.

On Thursday, President Trump announced plans to impose tariff increases on up to $60 billion of Chinese imports, following a seven-month investigation into intellectual property theft. The president directed US Trade Representative Robert Lighthizer to produce a proposed list of Chinese products to be hit with higher tariffs within 15 days, after which a finalized list will be made public. China’s commerce ministry revealed a list of 128 US products as potential targets for tariffs on Friday, in a retaliation to Trumps statement. This sent the S&P 500 tumbling almost 6% lower as the concerns of a global trade war heightened, marking the worst week for the Index since January 2016.

With the sharp move lower, stocks have now advanced or declined by more than 1% in 10 of the first 12 weeks in 2018, compared to only 13 such weeks in all of 2017. Furthermore, there have already been eight weeks this year in which markets have advanced or declined by more than 2%, with no such weeks in all of 2017. So with the continued volatility and recent downward pressure, is it time to worry about a more pronounced bear market or are we just experiencing a continued normal market correction?

As stated in our blog post from February 12, immediately following the sudden 10% drop in the S&P 500, a correction in the US stock market happens approximately once every year. Generally, less than 20% of market corrections turn into more pronounced bear markets, but even the average bull market correction takes around four months to recover back to new all-time-highs. While volatility has seemed high over the past couple of months, higher volatility can be expected during these pull-backs as investors recalibrate their portfolios. 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 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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