5-Minute Market Update // May 16, 2016

May 17, 2016

Posted May 16, 2016

 

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.

Market Update

Equities: The broad equity markets fell for a third straight week as earnings remained lackluster and economic growth remained slow, with disappointing quarterly data from major retailers. Utilities was the strongest performing sector while consumers discretionary, financials, and industrials lagged.

Commodities: Commodities saw moderate to large gains in oil, corn, wheat, gasoline, and gold (5 of the 6 largest constituents of the commodity index) for the week, with oil posting the largest gains. Oil has gained over 75% since the mid February lows, but remains well below its all time highs.

Bonds: The 10-year treasury yield continued to fall to 1.71%, leading to an extension of strong bond performance for the year. High yield option-adjusted spreads also continued a general decline from the recent highs in February, showing increasing investor confidence in a lower default risk. This lower high yield spread, however, contradicts the slowly increasing default rates experienced by high yield bonds, which is something to keep an eye on over the coming weeks & months.

Most indexes remain positive (modestly) for 2016.

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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.

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 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).

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Weekly Comments & Charts

The S&P 500 has continued to fall back toward its downtrend ceiling since reaching a YTD high of over 2,100 in April. This is something to keep an eye on as we have run into resistance near the mid 2015 all time high levels.

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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.

To compare this current trend to past major trends, let’s look at the charts for the years leading up to the two major bear markets during the 2000’s:

S&P 500 1998 – 2000

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S&P 500 2006 – 2008

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As we can see, initially there were definitive up-trends in the years leading to the bear markets of 2000-2002 & 2008. Eventually, the markets hit a ceiling and failed to break through it multiple times. Volatility increased as the markets saw lower lows and lower highs, until we eventually ended up in a definitive downward trend. It is still too early to make any definitive conclusions about the current market direction, but there is an eerie similarity between these charts and the current position we are in.

While market trends 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.

 

Regards,

Mike Lester

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