The market has been very volatile this quarter with a sharp downswing followed by a very nice recovery. The main driver of both was the price of oil. The early fears associated with falling oil prices were mitigated by a recovery in the oil market. We believe that the market and oil will be highly correlated until oil prices stabilize and begin trading in a range.
The reasons for the high correlation are many. Investors feared that oil prices fell due to a decrease in demand, signaling the onset of a recession and the need to sell equities to buy risk-free assets. In addition, the extreme fall-off in oil prices created the need for sovereign wealth funds of oil-producing countries to sell global equity positions in direct investments and hedge funds to close massive budget deficits. Finally, companies in the energy sector have high percentages of leverage. Banks have exposure to the energy sector through loans. Unsurprisingly, as oil dropped during the selloff, we saw the banking sector nearly double the losses of the S&P 500.
But it felt like the market was at odds with the economic trends, which seem to indicate an improving U.S. economy. Wage growth rebounded in March and year-over-year 2.3% wage inflation points to a tightening job market. Unemployment is hovering around 5%, and the job participation rate moved higher for the fourth consecutive month. The housing market is showing a 4-month inventory of houses (normal is 6 months). Facts like these were punctuated with an exclamation point at, what now appears to be, the bottom of the selloff. On February 11th, J.P. Morgan Chase’s CEO, Jamie Dimon took $27 million of his own money and purchased 500,000 shares of his company’s stock, as if to say, “This selloff belies the fundamentals of the bank and the economy.” Perhaps not coincidentally, the market has rallied since then.
The international scene is a different story as the economic recovery overseas struggles to find its footing. The European and Japanese central banks have gone further negative with their short-term interest rates. These global growth woes are clearly influencing the Federal Reserve Board’s interest rate decisions, reinforcing the fact that the Fed’s decision to raise rates no longer is constrained by its original targets of 6.5% unemployment and 2% inflation. This makes sense given that raising rates would strengthen the dollar, which would result in lower oil prices and U.S. corporate profits. Both consequences would negatively affect the U.S. economy.
Looking forward, we look for oil-producing countries to freeze and even cut production, creating enough price stability needed for global growth to gain traction. However, that could take some time. And while U.S. households are saving their gas-pump stimulus for now, we expect that to change as labor markets continue to tighten and wages increase. Consider also that rising rents, slowly rising interest rates, and increasing household formations will provide a tailwind to the starter house segment of the housing market. In all this, the Fed will likely only raise rates once or twice in 2016 enough to confirm the recovery’s progress and avoid choking it. That said, the market feels like it’s done with its big jump. Thus, for now, we would favor individual U.S. dividend-paying stocks.
Please contact us if you have questions about your individual account. We would welcome the opportunity to talk with you.