The first quarter of 2016 was marked by two disparate halves. During the first six weeks of the quarter, U.S. and global stocks declined by over 10% as investors took a “glass half empty” view with regards to the Chinese economy, the price of oil, and the risk of a global recession. In the second six-week period, concerns around each of these factors waned, stocks rallied, and the quarter ended roughly where it began.
Perhaps the biggest driver of stock prices over the quarter was the daily price of oil. As the chart below illustrates, stocks and oil have traded in virtual lockstep over the past 3 months.
Source: Factset, as of March 28, 2016
During the first half of the quarter, “glass half empty” investors lost sight of the net benefits of cheap oil—namely lower expenses for consumers and lower input costs for businesses. They instead focused on the potential negative outcomes of energy-related defaults and bankruptcies, and the risks these events could pose to the broader economy. Low oil prices have never caused a recession, and weak prices continue to be the result of technology-driven oversupply, not lack of demand. The good news is that the supply/demand relationship always recovers to equilibrium over time; in simple terms, the cure for low oil prices is low oil prices. Most analysts currently expect 2016 production (including Iran) to be flat relative to 2015 levels, while 2016 consumption is expected to increase. Oil prices may continue to be volatile in the short term, but these fundamental factors should lead to a closer balance between supply and demand and help to stabilize prices at higher levels later this year.
While global risks remain elevated, we are generally constructive on the U.S. economic outlook for the remainder of the year. The U.S. economy continues to add jobs at a healthy rate, unemployment remains low, and wages have started to show modest growth. Household net worth is at an all-time high and energy costs and interest rates remain low. These factors support consumer sentiment and in turn consumer spending, which accounts for almost 70% of the U.S. economy.
Other positives include a slightly weaker U.S. dollar, a dovish Federal Reserve, an improving housing market, and a recent uptick in manufacturing. In addition, data that tracks leading economic indicators (LEI) is still trending upward, suggesting that the likelihood of a near term recession is low.
Weakness in corporate earnings growth remains a concern, but it should be noted that earnings have been relatively healthy outside of the energy sector. Analysts currently expect first quarter earnings to represent a bottom, with both revenues and earnings showing positive growth in the second half of the year. This is something we will be watching closely. Finally, in our view, the market is neither expensive nor cheap. U.S. stock prices are generally in-line with historical averages across multiple valuation measures, and therefore a neutral factor for returns at this time.
As the current bull market celebrated its 7th birthday on March 9th, it’s fair to question what life it has left. We remind investors that bull markets don’t die of old age. Rather, they typically succumb to common factors, including excessive valuations, aggressive monetary policy, commodity spikes, or recessions. We presently don’t view any of these factors as significant near term risks. Having said that, positive stock returns are likely to be more muted, and perhaps more volatile, as the current business cycle matures. The same likely holds true for bonds. As global interest rates sit at historically low levels, including negative rates in Europe and Japan, further meaningful rate declines seem implausible. Without the tailwind of falling rates, fixed income returns on average are expected to be less than or equal to bond coupon payments going forward.
The Wagner Wealth Team
* Information provided should not be construed as investment advice and is not meant to be taken as a recommendation to buy or sell. The financial situation and investment objectives of each individual must be considered for suitability prior to any recommendations being made.