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 mixed with small-cap US stocks experiencing the largest gains. S&P 500 sectors finished the week mixed with no discernable performance difference between defensive and cyclical sectors, though cyclical sectors experienced a wider range of positive and negative returns.
So far in 2017 technology, healthcare, and consumer discretionary are the strongest performers while energy and telecommunications are the only sectors with negative performance year-to-date.
Commodities: Commodities were negative for the week as oil prices fell 3.84%. Oil prices had been trending upward following a report showing falling US crude oil inventories on May 10, but have dropped sharply again on disappointment that the extension of OPEC output cuts did not go deeper (investors were hoping for an even lower level of production rather than simply the extension of current output cuts). Gold prices fell 0.69% for the week, but gold remains moderately positive (+10.56%) for the year.
Bonds: The 10-year treasury yield increased from 2.15% to 2.21%, resulting in negative performance for treasury and aggregate bonds.
High yield bonds were negative as broad interest rates increased and risky assets experienced some downward pressure.
Indices are mostly positive for 2017, with equity markets leading the way while commodities and bonds lag behind.
Lesson to be learned: “Every once in a while, the market does something so stupid it takes your breath away.” – Jim Cramer. It can be easy to spot the moments of “market stupidity” in hindsight, but it is not always so clear at the time they are happening. As investors, we need to be prepared for the unexpected so we do not get caught up in the irrationalities the markets so often display. 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 8.94, 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 the week slightly negative after touching new record highs for the fifth consecutive week. The Index remains in the upward trend that began in mid-February 2016, though the current rally has slowed slightly in recent months. Short and intermediate-term momentum remains positive as many indices have reached new all time highs multiple times this year. 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 US stocks were mixed for the week as small-cap stocks rose over 1% and large-cap stocks were flat to slightly negative.
However, while US stocks in general continued to perform strongly, the heavily technology based Nasdaq index fell 1.55% during the week. This was the worst week of the year for the Index as a sharp 1.80% sell-off on Friday pushed prices lower. Prior to the drop on Friday, the Nasdaq index had been surging higher, reaching new all-time-highs numerous times in recent months (and in 10 of the previous 12 trading sessions). Even after the negative week, the Index is still up 15.32% year-to-date, far outpacing other major US indices. So what was behind the sharp sell-off on Friday, and was this a one-day anomaly or the start of a reversal in the surging technology sector?
The largest contributor behind the downward move seemed to be the growing concern among investors that some of the largest tech names (Apple, Amazon, Facebook, Alphabet aka Google, and Microsoft) have become overvalued. On Friday morning, Goldman Sachs wrote a widely read piece illustrating how the five stocks have been an integral part of the US market rallies, both S&P 500 and Nasdaq, so far in 2017. In the report Goldman Sachs stated that many investors may be leaning too heavily on the hot companies due to recent momentum, which was creating extreme positioning and an “air pocket” of extreme valuations. These five large companies fared worse than the broad Index, with Apple falling the most (-3.88%) on Friday.
The downward pressure increased throughout the day as more and more investors began reacting to the article and started taking profits from their recent gains. Some analysts believe this could be the start of a regime change, as investors may start to move away from momentum toward more value over the coming months, while others believe this could just be another short-term blip on the long-term growth chart for these technology giants.
While it is still unclear as to the severity and length of this tech sell-off, this is a prime example of why it is so important to include a broad range of asset classes in your portfolio for more consistent and more stable longer-term results. Individual stocks and indices can go from periods of over-performance to under-performance without a moments notice. It is crucial not to chase returns just because a stock is “hot” at the moment.
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