Market Update

Market Update

When is a trunk not a storage space in a car? When the conversation is about a large, grey mammal that lives in India. Context matters. Similarly, in volatile markets like these, it’s important to view the most recent events in the context of more impactful, longer term trends. That is, the 10 percent decline in January—is it the beginning of a bear market or a normal correction in a bull market?

A major driver of markets in 2016 has been the price of oil. With oil prices looking like they would hit $20 a barrel, there was a bounce this past week when traders caught wind that oil-producing nations finally seem likely to cut production to stabilize prices. This will help move oil prices out of the spotlight and decouple them from influencing the market direction.

Furthermore, investors expected interest rates to be a major driver of markets this year. Specifically, they were concerned that raising rates too quickly could choke economic growth. This week, the Fed left the short-term interest rate unchanged due to continuing global economic weakness. Investors now believe that the Fed will raise rates one to three times in 2016 instead of the four to six originally anticipated, helping to ease concerns of an overly-aggressive rate hike policy.

Like the Fed, we are concerned about a faltering global recovery. However, it is clear that central banks are committed to stimulating their economies through further quantitative easing. Last week, European Central Bank’s Mario Draghi hinted that more stimulus would be discussed at the ECB’s March meeting due to concerns of deflation. This week the Bank of Japan announced negative interest rates. That is, banks pay interest on cash they leave sitting at the Bank of Japan. Also this week, China’s central bank took action, injecting more liquidity into its economy. Central banks clearly are taking action.

Ultimately, the market volatility we have seen the past month is not going away in the near term. But looking out over the rest of the year, good unemployment numbers overall (there is regional dislocation due to job losses in the energy sector) and persistent lower oil prices will result in higher U.S. consumer spending in other sectors. The positive earnings reports coming out during this earnings season may be reflective of this longer-term expectation. If this indeed is a developing trend, the U.S. consumer will stimulate domestic economic growth. As such, we believe that when the market recovers, the 10-percent decline in January will not be viewed as a change in trajectory, signaling the start of a bear market. Instead, it will be seen as a normal correction in a continuing bull market.

As always, please contact the office if you have any questions.

Market Update

The world markets experienced a pullback this past week in reaction to events in China, a further decline in oil prices, and North Korea’s announcement that it detonated a hydrogen bomb (H-bomb).

In China, investors’ concerns over the Chinese economic slowdown resulted in panic selling in their stock market. The Shanghai Composite experienced a 7% drop on two different days, the last being Thursday. Due to the sharp sell-off, the Chinese market triggered “circuit breakers” that halted trading both days. The trading stoppage stimulated panic due to the perceived lack of buyers for those trying to sell their positions. On Thursday, the China government decided to suspend the circuit breakers to try and help price discovery. In addition, the Chinese central bank cut its benchmark lending rate. But to allay fears that China is devaluing its currency indiscriminately, the central bank also took steps to strengthen the yuan.

Oil prices followed suit this week, dropping another 10 percent down to around $33 per barrel. Supplies have continued to grow because the production of oil still exceeds consumption. Markets responded with a correlated drop as they have the past two years.

It didn’t help matters that earlier in the week the North Koreans staged a powerful explosion it claimed to be an H-bomb test. The latest provocation increased tensions in the region. All of North Korea’s neighbors, including China, responded by denouncing the claimed testing of a nuclear device.

The net result in the U.S. has been a lot of volatility and a 3 percent decline in the S&P 500. However, the US economic data continues to point to an economic recovery. For example, the most recent jobs report estimated that 292,000 new jobs were created in December. Furthermore, the numbers for both October and November were revised upward by 40,000 and 10,000 respectively. For all of 2015, 2.7 million jobs were added.

In addition, persistent low oil prices will facilitate the stimulation of consumer spending and help the retail sector to recover. Earnings season starts next week, which could be a chance for companies to deliver good news as a result of lower oil and energy costs. Although a reported 15% of the companies in the S&P 500 are negatively impacted by falling oil prices, the majority of companies have a positive reaction to lower energy prices.

Finally, the global uncertainty should cause the Fed to consider fewer interest-rate-hikes this year. At the end of 2015, most analysts thought the Fed would raise short-term interest rates at least six times. Now they are thinking more like two to four times. This means lower interest rates will likely persist longer than originally projected.

We believe that the market is oversold on a shorter-term basis. The oversold market coupled with improving jobs number and first-quarter earnings that companies will begin reporting next week should set up for a market rally over the next week or two.

This has been a volatile week. If you have any questions, please contact us.