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 in 5 minutes or less. After all, finances should be simple, not complicated.
Financial markets have put in a strong push the past few weeks, continuing with gains the last 5 days. Most “growth” asset classes are close to break even for the year now, and all “income” asset classes are positive.
Lesson to be learned: One week up (sometimes a few weeks 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.
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.
We want the Recession Probability Index (RPI) to be low on the scale of 1 to 100. One is great. 100 is a full blown recession. For the US Equity Bull/Bear indicator, we want it to be at least 67% bullish. When the RPI is low and Bull/Bear is high, our research shows market performance is strongest and least volatile.
The RPI increased slightly from 24 last month to 31, signaling a modest slowdown in the US Economy. The Bull/Bear indicator is unchanged this week (100% bearish). Historically, this means our models think there is a slightly higher likelihood of stock market declines in the near term (think <18 months).
The financial markets continue to battle back early year losses, and are broadly very close to turning positive. This is great news, though we’re not out of the woods just yet.
Per the chart below, we can still see the market is in a downtrend. It’s at the high end of the range, but definitely needs to break out of the red “channel” you can see drawn over the chart.
A definitive breakout would be an S&P 500 move above 2050, and then staying there or higher for a few weeks.
Until then we need to stay balanced, a touch more conservative than normal, and committed to our long term investment plan.
In our models we’re still cautious, but feeling more optimistic than we did in January and February. Our longer term trend indicators are still pointing to a good possibility of a bear market at some point this year. Because of this we need to be nimble, and pay close attention to potential warning signs. Should this happen, I’ll be sure to share them here on our blog.
That is your five-minute update.
If you are an economy nerd, then read on, although this is overtime analysis.
Federal Reserve Keeps Interest Rates Steady… As was widely expected, the Fed didn’t raise rates at its scheduled meeting this week. However, the Fed’s statement lowered the expected overnight rate by year’s end from 1.4% to 0.90%.
What it means – The markets didn’t zoom one direction or the other because the announcements weren’t surprising. The drop in the expected rate by the end of the year implies two rate hikes this year instead of the previous expectation of four. I don’t even think they’ll do that much.
What really caught my attention was Chair Yellen’s answer to a question on the Fed’s disappearing credibility as the central bank changes its position at every meeting. She made clear that the Fed makes no plans, no promises, and has no preset action from meeting to meeting.
Mrs. Yellen - this is YOUR JOB! The most influential central bank on the planet has no long-range plans, and can’t set out monetary policy longer than six weeks? The built-in uncertainty leaves markets, lenders, and other central banks twisting in the wind. Clearly, we can do better than this.
Bank of Japan (BoJ) Leaves Monetary Policy Unchanged, Notes that Rates Might Not Drop… Negative interest rates didn’t have the desired effect, so the BoJ hinted it might not move rates even further into negative territory.
What it means – Well, they’ve got to do something. Just a few months ago, the yen traded at 121 per U.S. dollar, and then it strengthened. The BoJ instituted negative rates and jawboned about their resolve to push it back down, but the reverse happened. Now the yen trades around 110 and BoJ officials are nervous.
A stronger yen hurts exports, which curbs corporate profits and dents wages. That won’t help their economy grow. Look for the Japanese to institute a weird new monetary policy aimed at driving the yen back above 120.
Chinese Property Market Based in Part on Peer-To-Peer Lending… Contrary to laws forbidding borrowed down payments, Chinese property owners routinely borrow funds from other consumers in the shadow banking economy.
What it means – In January Chinese property buyers borrowed roughly $153 billion for down payments. As long as prices go up, there’s no problem. But when prices roll over, just as we experienced in the U.S. in 2008, highly leveraged homeowners quickly default, which leads to greater price declines and even more defaults. It sounds like a death spiral waiting to happen.
Market Gains and Financial Engineering . . . A March 16th article from Business Insider stated that a HSBC research report concluded most of the stock market gains since 2009 is due to buyback fueled by Quantitative Easing. The report states that S&P 500 companies have bought back $500 billion in stock in the last two years, and $2.1 trillion since 2010. Individuals and pension funds have not been a significant part of the market’s growth
What this means – This report concludes the market rise since 2009 is mainly Financial Engineering. Absurdly low interest rates allow companies to take on debt and buy their stocks so they can juice their earnings per share. But, it’s a low-quality source of earnings growth and has nothing to do with demand for a company’s products or services, plus it inhibits innovation and R&D.
Buyback are now long in the tooth, so where is our seven-year bull headed? Liz Ann Sonders, Chief Strategist at Charles Schwab, stated that individual investors and pension funds will come into the market now. Hmmm, are these the same individual investors who have seen their wages decimated and expenses skyrocket (health care and education, etc.)? And pension fund managers are not apt to make market timing bets.
Retail Sales Down 0.1% in February, Revised down 0.4% in January… Lower gas prices were a big part of falling sales. Excluding autos and gas, retail sales were up 0.3% on the month, and 4.8% on the year.
What it means – Falling energy prices are generally a good thing, so there’s no reason to sweat that part of the report. The problem is that after adjusting for inflation, retail sales are rising less than 3%. That pace doesn’t scream “breakout recovery,” which leaves the U.S. in the same economic mixed bag that it’s been in for years.
The Fed confirmed the slow pace of growth with their diminished forecast of GDP expansion this year and next, which now stand at 2.2% and 2.1%. What makes this worse is the Fed’s history of being too optimistic.
Consumer Prices Fell 0.2% in February, and Rose a Modest 1.0% Over Last Year… Excluding food and energy, prices rose 0.3% last month and increased 2.3% for the year.
What it means – Energy is still the main story when it comes to inflation, but that’s about to change. After stripping away the drop in oil, rising prices in other areas take center stage. Shelter was up 3.3% over last year, and health insurance rose an average of 6%. College tuition jumped 4.0%, while childcare costs increased 3.9%.
None of this is a surprise to consumers, who keep biting the bullet of higher costs while wondering when they’ll receive higher pay.
I expect the rise in energy prices to push next month’s index higher, masking higher prices in these other sectors.
Housing Starts up 5.2% in February, Permits Fall 3.1%... The gain in housing starts was almost entirely in single-family units, while the drop in permits was all in multifamily units.
What it means – Positive news in single-family units for both starts and permits is a good thing, since this is where housing creates the most middle-class jobs. It looks like new housing remains on a very slow but steady climb, even as the market breaks down between higher-priced home sales, which appear to be stagnating, and entry level, which are still moving at a fast clip. Demographically, this makes sense.
Oil Inventory Rose 1.3 million Barrels to a New Record of 523 million… Analysts expected four million more barrels, so prices rose on the news.
What it means – While slightly higher U.S. inventory on a slightly lower than expected build is worth mentioning, the big news in oil is the possibility of a meeting among OPEC and non-OPEC producers next month to discuss production cuts. The combination of these two tidbits sent the price of oil up more than 15% this week. But don’t let the volatility fool you.
The world still produces about two million more barrels of oil per day than it needs. All the talk in the world won’t change that. If some combination of supply and demand doesn’t change soon, oil will take another dive.