What has changed from January or from last September for that matter?
In short, not too much! But just a couple months ago, worries of recession flooded the news as the stock markets reacted in a matter of days to a host of global issues as well as an increasing amount of companies forecasting weaker earnings in 2016. Here we are just over one month later and the S&P 500 staged a momentous comeback to now sitting only 3% below its all-time high.
So what has actually changed? Because just the other day, Federal Reserve chair Janet Yellen basically announced that the global economy is worse today than it was in December, back when the Fed took its target rate up a quarter point.
One contributing factor could be the fact we saw oil come of its lows of $26 a barrel in January with hopes that major oil producers, including OPEC nations and Russia, would reduce production in unison, but that is looking unlikely as both Iran and Libya won’t participate and plan to drill more. Global inventories in March were still at record highs for many countries while there is still question to lower global demand for 2016. There continues to be a lot of conjecture concerning the direction the price of oil will go and for how long.
Another contributor could be the fact that the economic data in the U.S did not present any new or worsening conditions. According to the data, the U.S economy is continuing on its current, albeit slow growth path.
Finally, I guess the market liked the fact that the fed said they would hold off on a rate hike and commented that rates may only rise once before year end, maybe not.
So let’s get to the point. What should we expect?
The good news is that the U.S. economy still appears to remain within the expansion cycle that we normally see after a recession or contraction. Usually towards the later part of the cycle we would start to see inflationary pressures, reduced profit margins and less availability to credit causing overall returns to become more muted. At this time we don’t see any signs of late-cycle pressures which means most of the pressures on the markets are continuing to arise from concerns in other parts of the world as well as continued pressure on commodities, specifically oil and energy sector.
Globally things are far worse as we saw steep declines in global assets linked to commodities and emerging markets. However the Eurozone and Japan are still in outright easing mode. China’s is also still ramping up stimulus efforts emphasizing near-term macro stability over structural reforms.
The strength of the U.S dollar will likely cause persistent weakness throughout U.S. exporters and multinational companies, resulting in a decline in corporate earnings for the first half of 2016.
However, there were companies in certain sectors that did post positive earnings and positive guidance. Any stabilization in oil prices and/or the global macro backdrop could bode well for corporate earnings growth. And, with the already reduced market expectations, may provide a lower hurdle for positive earnings surprises towards the third quarter of 2016.
On a final note: Historically, equity returns have been slightly above average during presidential election years but other economic and corporate developments will likely be more important drivers of market performance this year. So we recommend sticking to sectors that have historically performed well in the current and potentially upcoming cycle phases for example technology, commodities, and staples.
An economic update is not fun without at least one fun chart.