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.
Commodities: Commodities saw gains for a second straight week (making 6 of the past 7 weeks positive for commodities) largely due to increases in oil and gasoline. Oil has gained over 75% since the mid February lows, but remains well below its all time highs.
Bonds: The 10-year treasury yield rose to 1.85% due to improved economic data leading to speculation that the Fed could raise rates as soon as June. This caused treasury and aggregate bond prices to decline for the week.
High yield option-adjusted spreads, however, continued a general decline, showing increasing investor confidence in a lower default risk. Lower spreads and positive equity performance helped high yield bonds increase for a second straight week (making 7 of the past 8 weeks positive for high yield bonds). Although high yield bonds have seen strong performance in 2016, they are experiencing slowly increasing default rates, which is something to keep an eye on over the coming weeks & months.
Most indices remain positive (modestly) for 2016, with commodities leading the way.
Lesson to be learned: Be patient. Markets can be frustrating as they swing up and down in the short-run, so sticking to a plan is imperative for success in the long-run.
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) has remained constant since the increase in March, which signaled a modest slowdown in the US Economy. The Bull/Bear indicator remains 33% bullish (67% bearish). Historically, this means our models think there is a slightly higher than average likelihood of stock market declines in the near term (think <18 months).
Weekly Comments & Charts
The S&P 500 did not show us much after a volatile week of trading. To continue tracking the chart we have been watching the past couple of months, the S&P 500 remains slightly above its downward trend ceiling.
If there is further movement to the downside and the ceiling is broken, it could signal yet another test of the current downtrend floor level near 1,825. Should the market stay above the downtrend ceiling near the 2,025 level, it could signal a new floor / support level which would likely lead to gains above the 2016 & all time highs.
Another interesting trend to keep an eye on is the spread between 10-year and 2-year treasury bonds.
When the line is higher it represents a higher spread (and a lower/negative spread when the line is lower). As we can see, the spread has been consistently declining since the beginning of 2014. Generally, a higher spread implies growth and expansion (due to lower short term rates), a lower spread (closer to 0) implies an economic transition from growth to slow-down, and a negative spread implies a potential upcoming recession (recessions are illustrated by the grey bars in above graph). The Fed directly influences short-term rates by buying/selling short-term treasuries, but long term rates are less influenced by the Fed due to the premium for uncertainty of rates in the distant future. If the Fed decides to increase rates soon, short term rates will likely increase faster than long term rates, leading to a continuation of this declining spread. There is no guarantee that a declining spread will cause us to see a recession, but it is definitely something worth paying attention to.
While market trends and history are useful for study, there’s always more to investing than just the charts. We still need to be a little cautious about earnings (they are broadly declining), the dollar (broadly declining also, sending oil back up), and an 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.