First Quarter 2016 Market Commentary
By Robert Stimpson, CFA
"Fact or Fiction"
Long-term investing takes a particular sort of constitution. Having the fortitude to weather market volatility, dissect fact versus fiction, suppress emotional decision making and fight the herd mentality is a perpetual battle. Yet, the first quarter of 2016 once again demonstrated why it is preferable to act on tangible information rather than on speculation and the market’s response to it.
The US stock market tripped hard over the calendar year-end mark, dropping 11% by mid January. Weak energy prices, negative interest rates in Japan, geopolitical strain in Europe and Latin America, concerns over the Federal Reserve’s (the Fed) interest rate increase plans and a slowdown in China conspired to crush investor sentiment and sent US stock prices tumbling. All of these concerns are valid and may ultimately affect global growth and stock prices. Then again, they may not. While legitimate influences, their actual effect on companies’ earnings or the stock market’s valuation is ultimately unknowable and thus still speculation. At some point, data will emerge that confirms fears. But for now, let’s look at some actual data that currently exists.
This first chart is the unemployment rate for the US economy. Despite concerns over economic growth due to the deflating shale boom, national unemployment is clearly trending in the right direction. After peaking close to 10% during the Great Recession of 2008, unemployment has returned to 2005 levels.
Civilian Unemployment Rate
The next chart is the Conference Board’s Index of Leading Economic Indicators. The top chart with the red line is the S&P 500 Index; the bottom chart with the yellow line represents the Leading Economic Indicators. The basket of highly sensitive economic statistics tends to give the earliest warnings signs of trouble for the economy. Noticeably absent in this chart is the volatility seen in the stock market over the last six months. Could this change? Sure, but for now the facts outshine supposition.
Conference Board's Index of Leading Economic Indicators
Since investing is a market of relative opportunities, our final chart shows the earnings yield of the S&P 500 compared to the 10-year US Treasuries. The green line charts the S&P 500 earnings yield; the blue line is the 10-year Treasury yield. When each investment is measured based on return for their expected cash flows over the long-run, US stocks still clearly offer better value than bonds. The current earnings yield for the S&P 500 is 5.35% compared to only 1.80% for bonds.
S&P 500 Earning Yield vs. 10-Year US Treasuries
These examples of stability and opportunity for US stocks contradict the fear and panic seen in the stock market in early 2016. Yet sounder minds prevailed and US stocks essentially reclaimed all of their lost territory by the end of the quarter. In the first quarter of 2016, the S&P 500 has gained 1.34%. Some of the previously shunned and weakest groups, such as mining and materials, have actually been amongst the strongest sectors for the last two months.
The point is that the stock market is fickle, volatile, and can change its mind overnight. Despite legitimate concerns for global economic Armageddon or a tone-deaf Fed, the stock market absorbs all information and sets in own course. More ‘dovish’ talk from Fed Chairman Yellen has helped reassure investors that the Fed is not dead-set on aggressive interest rate increase path and will moderate as needed. This has shifted expectations for further rate increases to the summer and maybe fall, allowing the low interest rate and low inflation environment to persist for a while longer. We have often written in these commentaries that stocks tend to thrive in a low inflation, slow growth environment. We do not see this backdrop changing in the near term. Therefore, despite somewhat elevated valuations and length of the current bull market, US stocks remain one of the most attractive global investment markets
Investing for the long-term is difficult when bombarded with information daily. Enhanced by the 24-hour media, Wall Street analysts promoting a differentiated ‘call’ and market gurus pontificating to enhance their personal ‘brand’, ultimately, stock market valuation multiples and earnings growth depend on the economic environment. For this reason, economic facts are always more reliable than sensationalized fiction.
Robert Stimpson, CFA
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This manager commentary represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. This information should not be relied upon by the reader as research or investment advice.
The S&P 500 Index is an unmanaged index, and its performance does not reflect management fees, transaction costs or expenses. The S&P 500 Index consists of 500 stocks chosen for market size, liquidity, and industry group representation. It is a market-value weighed index (stock prices times number of shares outstanding), with each stock's weight in the Index proportionate to its market value.
The Conference Board Leading Economic Index represents composite economic indexes which are the key elements in an analytic system designed to signal peaks and troughs in the business cycle. The leading, coincident, and lagging economic indexes are essentially composite averages of several individual, leading, coincident, or lagging indicators. They are constructed to summarize and reveal common turning point patterns in economic data in a clearer and more convincing manner than any individual component.
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