August 29, 2017
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 positive with small-cap US stocks experiencing the largest gains. S&P 500 sectors finished the week mostly positive with no discernable difference between defensive and cyclical sectors.
So far in 2017 technology, healthcare, and utilities are the strongest performers while energy and telecommunications are the only sectors with negative performance year-to-date.
Commodities: Commodities were negative for the week as oil prices fell 1.32%. Oil prices have been volatile so far in 2017 as the positive effects of strengthening demand have been conflicting with the negative effects of high global supply. Recent sentiment towards oil remains bearish amid fears the OPEC supply cuts may fall apart as countries continue to fall short of the pledged reductions. Gold prices rose 0.49% and remain moderately positive with a 12.82% gain YTD amid various political uncertainties.
Bonds: The 10-year treasury yield fell from 2.19% to 2.17%, resulting in positive performance for treasury and aggregate bonds.
High-yield bonds were positive as credit spreads tightened and most riskier asset classes performed well for the week.
Indices are mostly positive for 2017, with equity markets leading the way while commodities and bonds lag behind.
Lesson to be learned: “Remember that the stock market is a manic depressive.” – Warren Buffett. Sometimes the market is sensible and prices are based on economic and business developments. However, at other times the market can be emotionally unstable, swinging from euphoria to pessimism in an instant. By sticking to a disciplined investment strategy you can minimize the effect that emotions can have on your portfolio, improving your chances for 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 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 24.69, 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 negative for the second consecutive week, but remains in the upward trend that began in mid-February 2016. While intermediate and long-term momentum remains positive, shorter-term momentum has slowed as the Index closed below its three-month moving average for the first time since April. Many indices have reached new all time highs multiple times this year, illustrating there may still be further gains ahead, but volatility and downward pressure has slightly increased in recent weeks. 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
Broad US stock markets snapped their recent losing streak to finish the week positive on renewed optimism for tax reform.
Stocks received a boost as chief economic advisor Gary Cohn announced President Trump will start publicly campaigning for tax reform in the upcoming week. According to Cohn, “starting next week, the president’s agenda and calendar is going to revolve around tax reform… He will start being on the road making major addresses justifying the reasoning for tax reform and why we need it in the U.S.” Cohn mentioned the administration does not have a fixed / detailed tax reform plan, but they do expect it to include a one-time corporate tax repatriation on overseas profits as well as include protections for personal charitable, mortgage, and retirement savings deductions while taking away other deductions for individuals.
Further illustrating the renewed optimism regarding tax reform, small-cap US stocks markedly outperformed large-cap US stocks for the first week since June 26 – 30. Small-cap stocks surged immediately following the election with the idea lower corporate tax rates coupled with rising bond yields would drive investor cash to smaller companies. However, year-to-date the large-cap S&P 500 (SPY) is up 10.42% compared to only a 2.24% gain for the small-cap Russell 2000 (IWM) as interest rates remained suppressed and talks about tax reform seemed to have stalled. While it remains to be seen, if US growth continues to improve and tax reform gets pushed forward, it could lead to a resurgence of the smaller-cap US stock rally.
The recent divergences in stocks and increased volatility reminds us why it is important to include a broad range of asset classes in your portfolio for more consistent and more stable longer-term results. Individual stocks, sectors, and indices can go from periods of over-performance to under-performance without a moments notice.
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.