5 Minute Market Commentary – January 21, 2016

Trust Dale CFGI 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.

Market Update

The new year continues to be an unhappy new year for many investors…

The historically bad first week of financial markets has turned into a historically bad first two weeks. Per the table below, many stock indices are close to or have breached double-digit losses already. Will this continue forever? Not likely. But it is still frustrating for many and starting to cause some panic.

The good news is that there are some asset classes (bonds mostly) that are positive YTD, which means balanced to conservative investors are largely doing just fine. They might have small declines thus far, but nothing close to double digits.

This is just one of many examples why it pays to use a risk appropriate investment mix, and to never put all your investment eggs in one basket.

Screen Shot 2016-01-20 at 7.42.59 AM

Lesson to be learned: One week up, one week down (sometimes a few weeks down), one week flat. Markets can do this in the short term, which is why we have to invest for the long term.

FFI Indicators

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 be at least 67% bullish. When those two things occur, our research shows market performance is strongest and least volatile.

The Recession Probability Index (RPI) improved slightly in November, signaling an improvement in the US Economy. The Bull/Bear indicator had no change this week. Historically, this means our models think there is a slightly higher likelihood of stock market declines in the near term future (think <18 months).

Weekly Comments

Last week I published a post about this year’s market mayhem and how we were handling it here at FormulaFolios. If you didn’t get a chance to read that, I’d suggest following this link to check it out today.

Despite a very bumpy start to 2016 for many investors, those using diversified, risk appropriate portfolios are not feeling the extreme anxiety of investors who dumped their bonds and loaded up on just stocks. That was a popular (and now painful) investor approach the past couple years as investors (and professionals too) chased only the best performing investments of the past.

It should go without saying, but buying investments that made money last year does not provide you with last year’s returns. Rather, it often means you are buying high, the opposite of buying low and selling high. It’s an easy thing to get caught doing as it always feels good to have a basket of investments that look good in the rear view mirror. Unfortunately, there’s not much science to it, and it doesn’t tend to produce great results.

It’s important to start with a financial plan before making investments. The plan should help define a risk appropriate portfolio that will help meet your long term financial goals. Then comes the hard part…you have to stick with that risk appropriate portfolio for the long term, even when the markets are frightening in the short term. It’s an exercise in patience, and not one all investors succeed in.

The rewards, however, are worth it. Short term volatility is the price of admission to long term financial success. Nothing worth achieving (generally) comes easy.

Looking forward, we continue to advocate investors remaining balanced to cautious, and no matter how hard it might be, remaining patient. The markets look more bearish than bullish, and until that trend reverses, we’re wise to be patiently cautious.

More to come soon. Stay tuned.

Regards,

Phil Calandra and Jason Wenk
Chief Investment Strategists

Will the January Market Drop Ever Stop?

bull bearAs I write this the S&P 500 and Dow Jones Industrial Average are both down more than 8.5% YTD. Just today, the Dow was down nearly 450 points. Many investors are concerned, and wonder if this will turn into a much worse and much longer decline.

I have good news and bad news on this front.

Good News

The good news is there are many times when the market drops 8% or more. In fact, this happens in most calendar years between the start and finish, even though more often than not the market finishes up (about 78% of the time). So intra year declines is nothing new and happens all the time. It’s nothing to be overly concerned about.

When it happens to start a year it just seems a lot worse, especially since the second half of 2015 was also slightly down. See below for a graphic from First Trust Portfolios that illustrates the calendar year returns the past 35 years along with the largest intra year decline.

Screen Shot 2016-01-15 at 10.18.40 AM

Bad News

The bad news is that nobody knows exactly how large declines might be or how long they might last. The only thing we know is that when investing in securities it takes patience and the willingness to experience short term declines in order to reap the long term benefits.

How We’re Managing These Turbulent Markets

Here at FormulaFolios we have multiple models we follow each day to help us reduce volatility and market drawdowns. The models are not perfect, and certainly don’t work every time. There is never a guarantee against loss when investing.

That said, we’ve been quite defensive for nearly 6 months now. Most of our portfolios have been 50% or more in cash or short term treasury bills during this recent decline. As a result, we have losses in many portfolios, but they are quite modest when compared to the broad markets. Further, we believe in risk appropriate, balanced investing. This means many of our clients have a highly diversified portfolio of many asset classes, including bonds. Diversification like this is important because most bond indexes are actually positive thus far in 2016 (modestly, but still positive).

See the below chart showing the S&P 500, DJIA, International Stocks (all down about 8.5%), along with the Aggregate Bond Index (up just under 1%) year to date. This really helps drive home the value of a well balanced investment plan.

Screen Shot 2016-01-15 at 10.09.07 AM

By following our systems and deploying a well balanced investment plan, we feel it when the market drops, but the declines are smaller and easier to recover from. We still need to be patient though, as do all investors. It’s just a lot easier to remain patient when we know there are systems in place to help protect portfolios, and ample diversification to ensure we are not over committed to risk assets (like stocks this year).

Be a Wise Investor

We believe the wiser investor should resist the urge to “do something” when markets get volatile. Throughout history there have been many, many declines. Sticking to a smart, long term investment plan, is truly the right thing to do.

Expect to hear more shortly. As the markets get scarier, I’m always happy to share more knowledge to help investors reach their long term goals.

To smarter investing,

Phil Calandra

 

What Is Happening To Your Retirement Money?

Stock Market RollercoasterAs many of you are aware the stock market has had rough start of the year with most indices down about 7-10%. In our stock portfolios, we started to get more defensive about a month ago.

This is how I view the current stock market. The odds are high; with over a 75% chance we are already in a bear market, please see the article below. Remember, we employ a tactical-active money management style, where we allocate out of stocks to avoid most of the decline.  When the bear market ends, we then reallocate back into stocks and high yields bonds at deeply discounted prices, and begin to profit from the new emerging bull market. Furthermore, at the beginning of a bull market is where we can make the big money gaining 30 – 40% much like we captured in 2009 and 2003.  The last bear market was in 2008 – 09 and we played it well. Protecting our principal during 2008, then reallocating back into the markets in 2009. While the typical buy and hold investor, who employs modern portfolio theory, lost about 50% of their portfolio’s value. The important point is: we employ an active-tactical strategy, which allows us to play great defense and to protect our portfolios from the ravages of a bear market, then capture huge gains as the new bull market runs higher.

Anticipating the Market Cycle’s “Standard, Run-of-the-Mill” Outcome

What can investors expect when the current bull market reaches its end? John Hussman, former professor of economics and international finance at the University of Michigan and now stock analyst and founder of Hussman Funds, maintains, “A 50% market loss isn’t a worst-case scenario. Given current valuations, it’s the standard, run-of-the-mill outcome that investors should expect over the completion of this cycle.”
Will Hussman’s expectations become reality? Only time will tell, but to invest profitably in equities, it is essential to understand that financial markets move in broad cycles from bull to bear market. With every bull cycle there seems to come the cry that this time it is different. But throughout the history of the stock markets, it has never been different. The prudent investor accepts that it may never be different, if only because stock markets are the products of human emotions, and nothing in history tells us that human emotional responses have changed.

The Federal Reserve has encouraged investors to believe that volatility and downside risk can be removed from the market through the manipulation of interest rates, eliminating normal cyclical fluctuations. The problem with this approach is reflected in the theories of economist Hyman Minsky –When times are good, investors take on risk; the longer times stay good, the more risk they take on, until they’ve taken on too much. The consequence of artificially prolonging the good times and distorting normal market action can be far more violent market behavior over the completion of the cycle than investors would have faced otherwise.

Rather than avoid the mention of bear markets, it helps to look the bear straight in the face and develop strategies to moderate its damage.

Between 1929 and 2014 there have been 15 bear markets (periods when the S&P 500 fell at least 20%). The average bear slashed more than 38% from the S&P 500 value. Omit the 1929 crash when values declined 87% and the result is still an average loss of 33%. A new bear market began on average every five years, with the market taking an average of 3.6 years to return to its prior high.

S&P 500 Index Bear Market Study 

September 1929 through 2014

Bear Market Duration % Decline Time to Return to Breakeven
Sept. ’29 – June ’32 33 months 86.7 25.2 years
July ’33 – Mar. ’35 20 months 33.9 2.3 years
Mar. ’37 – Mar. ’38 12 months 54.5 8.8 years
Nov. ’38 – Apr. ’42 41 months 45.8 6.4 years
May ’46 – Mar. ’48 22 months 28.1 4.1 years
Aug. ’56 – Oct. ’57 14 months 21.6 2.1 years
Dec. ’61 – June ’62 6 months 28.0 1.8 years
Feb. ’66 – Oct. ’66 8 months 22.2 1.4 years
Nov. ’68 – May ’70 18 months 36.1 3.3 years
Jan. ’73 – Oct. ’74 21 months 48.2 7.6 years
Nov. ’80 – Aug. ’82 21 months 27.1 2.1 years
Aug. ’87 – Dec. ’87 4 months 33.5 1.9 years
July ’90 – Oct. ’90 3 months 19.9 0.6 years
Sept. ’00 – Mar. ’03 30 months 49.0 6.8 years
Oct. ’07 – Mar. ’09 18 months 47.8 5.5 years
Source: Telephone Switch Newsletter, Summer 1992. Updated through 2014 by Financial Communications Associates, Inc.

When will the current trend end? There is no precise way to know and betting against the trend can be a losing proposition. John Maynard Keyes may have said it best with, “Markets can remain irrational longer than you can remain solvent.” By recognizing the reality of bear markets and understanding the damage they can cause, the prudent investor puts in place tools to determine when the risk of a downturn outweighs the potential benefit of staying in the market and then executes those plans as trigger points are met.

Equally important, the investor has to have a plan for reentering the financial markets to take advantage of recovering values.

It is hard to overstate how important minimizing losses can be. It doesn’t take a 50% gain to recover from a 50% loss. It takes 100% because you are starting from a much lower base. Any time investors can minimize drawdowns in a bear market, they have added leverage to benefit from the market’s upturn, even if they miss the early stages of the market’s recovery.

For many investors, recovery is prolonged because of the emotional cost of losing money to a bear market. Too often investors who believe they are in for the long run sell out at the market’s bottom and then hesitate to return to equities until they have missed a major part of the market’s recovery. This is why we believe active management is essential for the long-run success of our investors.While there can be no guarantee that an active strategy will be successful, buy-and-hold investing guarantees bear market losses.

We welcome the opportunity to explain our investment approach. If you have any questions about how we manage client portfolios and where your assets are currently invested, please contact our office and let’s talk.

5 Minute Market Commentary – January 11, 2016

Trust Dale CFGI 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.

Market Update

Maybe it’s not a happy new year for most investors?!

The first trading week of 2016 was terrible. Markets broadly had one of their worst opening weeks in years (actually the worst ever for the Dow and S&P 500 according to Standard and Poors), leaving many investors concerned over what comes next.

For some perspective on the global nature of 2016’s bad start, see the graphic below from Visual Capitalist:

Courtesy of: Visual Capitalist

 

Bad first weeks are frustrating, but as you’ll learn later in this post, it really isn’t that significant if we are long term investors. It’s a bump in the road of 250+ trading days for the year. Although most of us would agree we would much rather start the year with a boom than a bust.

I’ll explain the significance of poor market starts in the Weekly Comments section below.

Screen Shot 2016-01-11 at 8.42.59 AM

 

Lesson to be learned: One week up, one week down, one week flat. Markets can do this in the short term, which is why we have to invest for the long term.

FFI Indicators

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 be at least 67% bullish. When those two things occur, our research shows market performance is strongest and least volatile.

The Recession Probability Index (RPI) improved slightly in November, signaling an improvement in the US Economy. The Bull/Bear indicator had no change this week. Historically, this means our models think there is a slightly higher likelihood of stock market declines in the near term future (think <18 months).

Weekly Comments

For about 6 months I’ve been advocating a balanced, but conservative approach to investing. It paid off when the market tumbled in August and September of 2015, but looked silly when the market tried to rally back in October and November. Now, those conservative investing pleas are paying off again.

We use a number of mechanical indicators to help us understand when markets are overly volatile and pose risks that we feel may make being fully invested less than ideal. Those warnings are still in place, and while they can be helpful in the long term, we still need to be weary of head fakes like we saw in October and November of last year. Our indicators are and have been providing warnings, and it’s been great we have been only about 1/2 invested to start the year.

But what comes next? How far will the decline go? Is this a buying opportunity or just a sign of more market losses to come?

History is no guarantee of future results, though I still feel it is worthy of learning from.

Taking a closer look at historical market statistics we know the following:

  • When the first 5 trading days in the S&P 500 are positive, the market has finished positive 86% of the time.
  • When the first 5 trading days in the S&P 500 are negative, there is no statistical bias whether the market will finish up, down, or sideways. In other words, a bad start to the year does not mean the market is more or less likely to continue that trend.
  • When the month of January (still a few weeks to go) is positive, the S&P 500 has finished up 73% of the time.
  • When the month of January is negative, the S&P 500 has finished up about 50% of the time.

Source: Stock Market Almanac

As you can see, a bad start doesn’t necessarily mean a bad finish. Good starts provide better historical odds, but a bad start (whether measured in the first 5 days or the entire month) does not mean that’s how the rest of the year will play out.

One of the biggest culprits to 2016’s rough start is the Chinese stock market. It declined over 12% last week. Combined with the US already beginning to raise interest rates, and a slower (but still growing) economy stateside, there’s more pessimism than optimism to start the year.

In the end, however, the US economy is not the problem. Jobs are being created, money supply is still abundant, and many of the risks to our last recession are not present (the financial system and real estate markets are nothing like they were in 2007).

To me, this feels like a possible bear market correction, and possibly a mild recession, but not the “big one”. When markets have more modest corrections they sometimes will turn into a bear market, and that’s perfectly normal. This could mean equity markets decline 20% or more over a 6 month or longer time period. It’s not the end of the world, and those who have made move to their portfolios to be more balanced and conservative will be just fine.

In our case, we’ve done just that, and while having losses is no fun, having small losses is better than large losses. When the market declines it creates future opportunity, but only those that stay committed will be able to benefit from that opportunity.

Looking forward, we continue to advocate investors remaining balanced to cautious, and no matter how hard it might be, remaining patient. The markets still haven’t made up their mind as to the current trend, and until that happens, we’re best to remain partially committed.

More to come soon. Stay tuned.

Regards,

Phil Calandra and Jason Wenk
Chief Investment Strategists

Portfolio Recap – December 2015

Screen-Shot-2014-10-07-at-11.56.40-AMIn this recap, Jason Wenk, we cover the prior month and YTD performance, touch on current asset allocation of our tactical models, as well as the most up to date economic analysis of our proprietary economic model – the Recession Probability Index.

Warmest Regards,

Phil Calandra and Jason Wenk
Chief Investment Strategist
FormulaFolio Investments, LLC

5 Minute Market Commentary – 1/5/2016

Trust Dale CFGI 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.

Market Update

Happy 2016 everyone!!

Only downside to the new year thus far is that, as of this writing, the market has decided to have it’s worst first trading day in years. Most equity markets are broadly down 2% or more midway through Monday the 4th.

That being said, it is a new year, and the first day is largely meaningless if we are long term investors. It’s a bump in the road of 250+ trading days for the year. Although most of us would agree we would much rather start the year with a boom than a bust.

This seems to be a continuation of the fizzle that 2015 ended with. Per below, you can see the losses from the past year pushed most markets into the red. This marks the first negative year for many markets since 2008.

Lesson to be learned: One week up, one week down, one week flat. Markets can do this in the short term, which is why we have to invest for the long term.

FFI Indicators

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 be at least 67% bullish. When those two things occur, our research shows market performance is strongest and least volatile.

The Recession Probability Index (RPI) improved slightly in November, signaling an improvement in the US Economy. The Bull/Bear indicator had no change this week. Historically, this means our models think there is a slightly higher likelihood of stock market declines in the near term future (think <18 months).

Weekly Comments

One of the good things about a new year is the opportunity for fresh starts. I think a lot of investors are eager for this as 2015 was not a good year for most investors (professional or otherwise). The sudden drop in August and quick rebound in October was nearly impossible to forecast. Those that simply rode through the ups and downs finished down a little for the year, while those that tried to be defensive after the initial drop found themselves locking in small losses, which added up to an underperforming year.

Sometimes this is the curse of the conservative investor. By protecting from larger scale losses, we sometimes miss out on short term recoveries. Then again, the markets have started to drop lower again here recently, so the conservative investor may not be so cursed after all.

In the end, investing is a long term journey. Those who get too flustered in the short term will always have a hard time being rewarded in the long term.

Looking into the new year, we continue to advocate investors remaining balanced to cautious, and no matter how hard it might be, remaining patient. The markets still haven’t made up their mind as to the current trend, and until that happens, we’re best to remain partially committed.

More to come soon. Stay tuned.

Regards,

Phil Calandra and Jason Wenk
Chief Investment Strategists