Thursday, September 28, 2017
5-Minute Market Update | September 25, 2017
By Darrell Bryant
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 mixed as cyclical sectors generally outperformed defensive 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 rose 1.54%, marking the third consecutive week of gains. Oil prices have experienced strong upward pressure in recent weeks as Hurricane Irma was less devastating than initially anticipated, resulting in higher near-term demand expectations. Gold prices fell 2.09% amid increasing interest rates and a stronger dollar, but remain positive with a 12.83% gain YTD.
Bonds: The 10-year treasury yield increased from 2.20% to 2.26% as the Fed announced it will begin unwinding its balance sheet in October, resulting in negative performance for treasury and aggregate bonds.
High-yield bonds were flat as the positive performance in riskier asset classes was mostly offset by higher interest rates.
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 22.06, 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 flat for the week and remains firmly in the upward trend that began in mid-February 2016. While shorter-term momentum has slowed in recent months, the Index has continued to reach new all-time highs throughout the year and recently closed above 2,500 for the first time in history, illustrating there may still be further gains ahead. While volatility and downward pressure has 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 313 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
Broad equity markets, led by small-cap stocks, climbed higher as the Fed announced its plan to begin unwinding its balance sheet in October.
Following the conclusion of its most recent meeting, the Federal Reserve announced it will begin unwinding its balance sheet next month. This balance sheet normalization path is the same as what was stated in previous communications by the Fed – the selling and non-reinvestment of $10 billion every month starting in October, increasing in $10 billion increments each quarter until the value reaches $50 billion per month next year. While this seems like a large value on the surface, the unwinding will be relatively gradual as the Fed will have sold just $450 billion of assets by the end of 2018 compared to the current $ 4.5 trillion total balance sheet.
Additionally, though the Fed announced it would keep the target federal funds rate at 1.00% – 1.25%, expectations for one more rate hike before the end of 2017 increased from a 57% probability to a 73% probability according to the CME Group’s 30-Day Fed Fund futures prices. This increase in rate hike expectations resulted from a somewhat hawkish “dot plot” released by the Federal Open Market Committee as members anticipate one more rate hike by year-end. Similar to the unwinding of the balance sheet, future rate hikes are expected to be gradual and should have a minimal impact on broad equity markets through 2018 as corporate earnings and labor markets remain strong. However, the sustained upward pressure on interest rates may result in moderated bond returns over the coming years.
While markets remain healthy, it is important to remember every day is independent of the day before. Long-term market movements are based on forward guidance, not on what happened over the past week/month/year. This is 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.
Derek Prusa, CFA, CFP®
Senior Market Analyst