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 negative with small-cap US stocks experiencing the largest losses. S&P 500 sectors finished the week mixed as defensive sectors generally outperformed cyclical sectors.
So far in 2017 technology, healthcare, and materials are the strongest performers while energy and telecommunications are the only sectors with negative performance year-to-date.
Commodities: Commodities were positive for the week as oil prices increased 1.98%. Oil prices remained at the highest levels in over two years, largely supported by continuing expectations that OPEC and other producing countries will extend a deal to cut output. Gold prices increased 0.39%, snapping a three week losing streak and helping gold to remain modestly positive with a 10.80% gain YTD.
Bonds: The 10-year treasury yield rose from 2.34% to 2.40%, resulting in negative performance for treasury and aggregate bonds. Yields have been trending up since early September, but have subsided since President Trump nominated current Fed Governor Jermoe Powell as the next Federal Reserve Chair. Powell’s views on raising interest rates are similar to current Fed Chair Janet Yellen – investors expect a slow-and-steady path of rate increases over the coming year with the nomination.
High-yield bonds were negative as the renewed uncertainty surrounding tax reform caused riskier asset classes to falter and credit spreads to increase. However, 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 indices are currently positive in 2017, with equity markets leading the way while commodities and bonds lag behind.
Lesson to be learned: “It takes twenty years to build a reputation and five minutes to ruin it. If you think about that, you’ll do things differently.” – Warren Buffett. Sadly, the same can be said about your portfolio (see global stock markets in 2008). However, by keeping a smart and disciplined investment strategy and maintaining a broadly diversified blend of assets, you can improve your probability of long-term success and minimize the negative impacts that extreme bear markets can have on your financial well-being.
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 19.40, 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 slightly negative, snapping a streak of eight consecutive weeks of gains (the longest weekly winning streak since 2006). However, the Index remains firmly in the upward trend that began in mid-February 2016. Shorter-term momentum has continued in recent weeks as the Index has continued to reach new all-time highs, illustrating there may still be further gains ahead. While volatility and downward pressure had slightly increased in recent months, 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 348 trading days – the fourth 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 stock and bond markets ended the week negative on tax reform uncertainties as investors reflect on the one-year anniversary of the US presidential election.
Last week marked the one-year anniversary of the US presidential election. While there was a large amount of uncertainty leading up to (and immediately following) the election, the US stock market has experienced a steady rally since early November 2016. The S&P 500 has returned over 23% since the election and is in the midst of the fourth longest streak without a 5% correction in history. During this run, the Index has recorded 59 new record highs so far in 2017, as investor confidence has been on the rise and earnings growth has been modestly strong. Sector performance has also reflected this trend as cyclical sectors have been outperforming defensive sectors significantly over the past year.
Broad economic growth has also gained some traction as GDP has averaged 2.4% in the first three quarters of 2017, including two consecutive quarters of 3% or higher growth for the first time since 2014. The labor market has continued to strengthen as the unemployment rate has fallen to a 17-year low of 4.1%. As the economy has remained healthy, the Federal Reserve has raised rates three times in the past year – the most rate hikes in a 12-month period since 2004 – 2005.
While this positive market performance cannot singularly be credited to the outcome of the election, there are some underlying political reasons behind the past 1-year market trends. Generally speaking, consumer confidence has been rising on the prospects of deregulation and tax reform, helping boost the prospects of continued economic expansion and leading to higher household spending (the largest contributor to GDP growth). As the past week illustrated there is still much uncertainty surrounding tax reform, but the coming weeks should provide more clarity about this major topic.
Though markets remain in an upward trend, it is important to remember the future is largely independent of the past. Broad US stocks have been experiencing strong gains with minimal volatility and virtually no drawdowns so far in 2017. In this environment, it can be easy to forget there are risks to investing. However, it was less than two years ago (at the beginning of 2016) when the US stock market experienced the worst start to a year in recorded history. 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 “hot” 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
*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.