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.
Equities: Broad equity markets finished the week mixed with large-cap US stocks experiencing the largest gains. S&P 500 sectors finished the week mostly positive as defensive sectors generally outperformed cyclical sectors.
So far in 2017 technology, healthcare, and consumer staples are the strongest performers while telecommunications and energy are the only sectors with negative performance year-to-date.
Commodities: Commodities were negative for the week, though oil prices rose 1.10%. Speculation regarding OPEC production cuts has pushed oil prices up since late November, but an increase in US production has given investors pause so far in 2017. Gold prices increased for the eighth time in nine weeks, posting a 1.56% gain.
Bonds: The 10-year treasury yield fell from 2.42% to 2.31%, leading to the strongest gains for treasury and aggregate bonds since the last week of 2016.
High yield bonds were positive as credit spreads remain relatively low and riskier assets performed moderately well.
Most indices are currently positive for 2017, with large-cap US stocks leading the way.
Lesson to be learned: Fred Schwed Jr. once said “Speculation is an effort, probably unsuccessful, to turn a little money into a lot. Investment is an effort, which should be successful, to prevent a lot of money from becoming a little.” It can be difficult to avoid the urge of speculating about “hot” stock tips which can allegedly make you rich overnight. The truth, however, is markets often act in ways that are unforeseen. This is why it is important to maintain a smart and disciplined investment strategy while avoiding knee-jerk reactions based on daily market noise.
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 25.44, 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 positive and remains well above the support level that was set following the breakout in July last year. The most recent positive price movement snapped a narrow trading range experienced by the S&P 500, in which the Index had closed within a 1.75% range for 31 consecutive trading days. It appears that US equity markets are currently in an intermediate-term upward trend as many indices have reached new all time highs multiple times in recent weeks. The coming weeks should continue to give valuable insight about the near-term direction of the S&P 500, but it seems the sideways/downward pattern experienced from 2015 through mid-2016 has shifted to a more bullish pattern for now.
Many US stock markets experienced gains for the fifth consecutive week as indices continue to reach new all-time highs.
The recent run-up can largely be attributed to speculation surrounding expected tax cuts and other policies leading to stronger US economic growth, but there is also fundamental support to the current rally.
So far, 92% of companies in the S&P 500 have reported earnings for Q4 2016. On December 31, total Q4 S&P 500 earnings were expected to grow only 3.1% year-over-year. However, after numerous upside surprises, the blended growth estimate has increased to 4.9%. As of today, 66% of reporting S&P 500 companies have beat their expected earnings estimate. Every economic sector, other than telecommunications, has experienced an overall positive earnings surprises.
This stronger than expected earnings growth data is good news as the forward 12-month price-to-earnings (P/E) ratio is currently at its highest level since 2004. The forward P/E ratio of 17.7 is well above the 5-year and 10-year average levels of 15.2 and 14.4. An inflated P/E ratio can indicate an overvalued market. To fall back to the average P/E ratios we would need to see earnings continue to increase, stock prices start to decrease, or a combination of both. If earnings continue to grow, it could help the recent bull-market continue through 2017 by keeping valuations at a reasonable level.
Though US stocks appear to be on track to continue performing strongly for the near future, it is important to include other broad asset classes in your portfolio for more consistent, more stable longer-term results.
While market trends and history are useful for study, there’s always more to investing than just the charts and trends.
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
*Investing involves risk including the potential loss of principal. No investment strategy can guarantee a profit or protect against loss in periods of declining values. Opinions expressed are subject to change without notice and are not intended as investment advice or to predict future performance. Past performance does not guarantee future results. Consult your financial professional before making any investment decision.