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 were positive through Thursday’s close, but traded down sharply on Friday (between -3% to -9% for the day) as the U.K. voted to leave the European Union (EU). This severe sell-off caused equities to finish the week negative. Defensive sectors had the strongest weekly performance, with only telecommunications having positive performance, while cyclical sectors lagged behind.
So far in 2016 telecommunications, utilities, and energy are the strongest performers while financials, health care, technology, and consumer discretionary are the only sectors with negative performance.
Commodities: Commodities saw losses for a second straight week, lead by declines in oil and agricultural goods. Though commodities had a negative week as a whole, gold posted a 2.13% gain and reached its highest intraday level since March 2014 due to an increase in demand for safe-haven assets after the Brexit vote.
Bonds: The 10-year treasury yield fell for a fourth straight week from 1.62% to 1.57%, resulting in yields remaining at the lowest levels since August 2012 and helping treasuries and aggregate bonds to have another positive week.
High yield bonds also had a slightly positive week as a decrease in general interest rates helped overcome the negative impact of the global shift away from riskier asset classes.
Most indices remain positive (modestly) for 2016, with commodities still leading the way.
Lesson to be learned: Emotions can be our greatest enemy when it comes to investing. Do not let emotions guide your investment decisions and lead to self-destructive behavior. Instead, 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 fell from 31.29 to 25.33, which signaled a slightly positive 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 believe there is no clear direction for the stock market in the near term (think <18 months).
Weekly Comments & Charts
The S&P 500 fell for the third straight week since hitting a resistance point set by the all time high back in May 2015. It looked as if the markets were poised to test this resistance point again as of Thursday, and a breakthrough may have finally happened if the U.K. had decided not to leave the EU, but the -3.59% sell-off following the Brexit decision halted the upward momentum seen earlier in the week. If the market continues downward for the coming week(s), it is important to see if the downward trend ceiling acts as a level of support or if prices breakthrough this ceiling. For any real positive market momentum to pick back up we would like to see the ceiling act as support, which would help push prices back up again in an attempt to breakthrough the all time high level set back in May 2015. Until the markets can hit a new all time high and break through this resistance point, we will continue to trade in a sideways / downward pattern.
The Brexit decision caught markets off-guard on Friday as a majority of people expected the vote to result in a “stay in the EU” decision. This sent equity markets tumbling as global economic uncertainties increased. The initial market reaction was negative and severe, but where does this leave the global economy going forward?
It is expected that U.K. companies will see lower capital outflows due to increasing political tensions as well as increasing uncertainty surrounding the country. This would lead to a rise in unemployment and lower GDP in the world’s fifth-largest economy. Though this may be bad news for the U.K. directly, the primary fear is that this could spill over into the rest of Europe which could cause a slowdown on a more global scale. Due to the increasing global exposure of U.S. companies, a slowdown in Europe could quickly travel overseas.
As with most major events that add uncertainty to the global economy, equity markets are expected to decline in the near term as there is added downward pressure and volatility. This could persist until there is more clarity about the overall impact of the Brexit. Bond yields in general are expected to remain suppressed in the near term and money will likely flow from riskier assets (equities) to less risky assets (bonds, gold, etc.) until there is more clarity on the impact of the Brexit.
While market trends and history are useful for study, there’s always more to investing than just the charts. We need to be a little cautious about earnings (they are broadly declining), 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.