5-Minute Market Update | October 17, 2016
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, finances should be simple, not complicated.
Equities: Broad equity markets finished negative for the week 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 2016 energy, technology, and utilities are the strongest performers while healthcare is the only sector with negative performance year-to-date.
Commodities: Commodities were positive for the week as oil gained 1.08%. This is the fourth straight week of gains for oil as traders continue to drive up prices on OPEC and Russia production cut speculations. Gold increased 0.34% and remains considerably positive (+18.18%) for the year.
Bonds: The 10-year treasury yield increased from 1.73% to 1.80%, leading to negative performance in treasury and aggregate bonds.
High yield bonds were negative as broad interest rate increases added to losses experienced from the negative performance in riskier assets.
All indices are currently positive (modestly) for 2016, with high yield bonds leading the way.
Lesson to be learned: Benjamin Graham once said “In the short run, the market is a voting machine, but in the long run it is a weighing machine.” There is a lot of daily market “noise” that can cause unnerving volatility at times, but it is important not to let short-term speculations drive your investment decision making process. Instead, you should maintain a smart and disciplined investment strategy to improve your chances of long term portfolio success.
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 future posts, I’ll write more about how these indicators are built and why we feel they are important.
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) most recently increased from 22.76 to 25.46, which signaled a slightly negative shift in the US Economy. The Bull/Bear indicator is currently 33.33% bullish, 33.33% neutral, and 33.33% bearish (averaging 50% bullish and 50% bearish). This means our models remain neutral regarding the stock market direction in the near term (think <18 months).
Weekly Comments & Charts
The S&P 500 finished negative for the second straight week and sits right at the support level that was set following the breakout in July. Prices stalled during the summer as there had not been a definitive move up or down since the S&P 500 broke through the ceiling set back in May 2015, but the past few weeks have seen an increase in price movement as markets continue to speculate over interest rates and the upcoming election. This could indicate an important inflection point in the equity markets. If the S&P 500 continues to use this old ceiling as a level of support, it could signal that markets are experiencing true positive momentum and are ready to continue making new all time highs. However, if the S&P 500 falls below the ceiling, it could signal a decline back into the sideways/downward trading pattern experienced earlier in the year. The coming weeks should give some valuable insight about the near-term direction of the S&P 500.
Broad equity markets ended negative for the week as markets gear-up for the Q3 2016 earnings season.
The forward 12-month price-to-earnings (P/E) ratio of the S&P 500 currently stands at 16.4, higher than the 5-year and 10-year averages of 14.9 and 14.3. Though there is no exact signal level, an inflated P/E ratio can indicate an overvalued market. To fall back to the average P/E ratios, we would need to see an increase in earnings or a decrease in prices.
The S&P 500 is currently in an earning slump as the last five quarters have experienced year-over-year earnings declines. This is the first time the index has recorded five consecutive quarters of year-over-year earnings declines since Q3 2008 through Q3 2009. Weaker than expected earnings announcements from some of the major initial reporting companies weighed on stocks this week and analysts are expecting blended S&P 500 earnings to decline 1.8% for the quarter.
Analysts expect positive earnings growth to return in Q4 2016, with a current growth rate estimate of 5.6%. For all of 2017, analysts are projecting earnings growth of 12.8% as oil prices have stabilized through 2016. This could provide support for higher equity prices over the next year, but there are still many global uncertainties facing the markets to be conscious of.
While market trends and history are useful for study, there’s always more to investing than just the charts and trends. We need to be a little cautious about increasing global uncertainties and the election that is right around the corner.
Most importantly, 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