Equities Rally as Oil and Monetary Policy Remain in Focus
▪ Equity prices rose as markets continue to follow the lead from oil prices.
▪ Over time, we expect oil to stabilize and believe that global monetary policy remains a tailwind for risk assets.
▪ Turbulence is likely to continue, but for those who can tolerate the swings, we think it makes sense to stick with a pro-growth investment stance.
Volatility remained high last week as U.S. equities regained some ground, with the S&P 500 Index rising 1.8%.1 Stocks soared on Friday in response to the Bank of Japan’s decision to adopt a negative interest rate stance. Oil prices also rose over speculation that global production might fall. Corporate earnings were mixed, as results continued to be held back by the long-term decline in lower oil prices, a soft economic backdrop and the strong dollar.
Weekly Top Themes
1. Fourth quarter gross domestic product growth was soft. The economy grew an anemic 0.7% last quarter, with growth held back by slowing consumer spending and the first decline in business investment since 2012.2 A slowdown in inventory investment also detracted from results.2 For the year as a whole, 2015 growth increased a respectable 2.4%, matching the pace seen in 2014.2
2. Last week’s Fed meeting came with no real surprises as the central bank adopted a slightly more dovish tone. The Fed noted somewhat weaker economic growth, but also sounded upbeat about demand and employment indicators. Policymakers also indicated that inflation remains low and stated they were “closely monitoring global economic and financial developments.” Absent a quick and dramatic economic improvement, we do not expect another interest rate increase before June.
3. The energy sector continues to weigh on corporate earnings. With over half of companies reporting fourth quarter results, earnings are beating expectations by 4.9% and revenues are missing by 0.3%.3 Earnings-per-share are on track to be flat for the quarter, and up about 6% excluding energy.3
4. Consumer confidence may be slowly improving. The Conference Board’s Consumer Confidence Index increased 1.8 points in January, beating expectations.4 Consumers may be looking past equity market weakness and focusing on the positives.
5. The anticipated “oil dividend” has yet to appear. Since oil prices started falling in 2014, many observers (us included) expected to see an increase in consumer and business spending. It doesn’t appear that this has yet occurred, and it looks to us as if most individuals are saving their extra disposable income rather than spending it. We expect consumer spending to rise, but acknowledge that lower oil prices have so far caused more pain than benefits.
A Pro-Growth Stance Makes Sense, but Requires Patience
Investors have grown more risk-averse in recent weeks with slowing growth in China, oil price volatility, weakness in manufacturing and Fed policy topping the list of concerns. Economic data has generally been stronger than reflected by financial market movements, and investors seem to be ignoring positive economic news and overly focusing on the negatives. At this juncture, we think investors have three options: (1) retreat and unload risk assets in anticipation of a recession, (2) pause, become slightly more conservative and await more clarity, or (3) maintain a pro-growth stance and accept that more near-term turbulence may occur before risk assets experience a sustained upturn. We think the first strategy is overly pessimistic and believe economic fundamentals are better than what is priced into the market. The second option may be reasonable for investors who are having difficulty weathering the current volatility. But for investors with long-term time horizons, we think option three is most prudent.
It may take some time, but we expect that oil prices should stabilize and cease being the main determinant of global financial market prices. The long-term drop in oil should produce some economic stimulus and become more of a positive. Additionally, global monetary policy remains a tailwind for risk assets. The Fed is likely to raise rates, but any increase should be measured and slow. And last week’s news from Japan reiterates that policy around the world remains in easing mode. Investors are also awaiting signs of a global manufacturing recovery, which would promote greater confidence in the strength of the world economy.
Our view is that financial markets have overreacted to the negatives. Turbulence is likely to continue, but we expect both equity prices and bond yields to rise over the course of 2016.
1 Source: Morningstar Direct, as of 1/29/16
2 Source: Commerce Department
3 Source: FactSet
4 Source: Conference Board
The S&P 500 Index is a capitalization-weighted index of 500 stocks designed to measure the performance of the broad domestic economy. The Dow Jones Industrial Average is a price-weighted average of 30 significant stocks traded on the New York Stock Exchange and the Nasdaq. The Nasdaq Composite is a stock market index of the common stocks and similar securities listed on the NASDAQ stock market. FTSE 100 Index is a capitalization-weighted index of the 100 most highly capitalized companies traded on the London Stock Exchange. Deutsche Borse AG German Stock Index (DAX Index) is a total return index of 30 selected German blue chip stocks traded on the Frankfurt Stock Exchange. Nikkei 225 Index is a price-weighted average of 225 top-rated Japanese companies listed in the First Section of the Tokyo Stock Exchange. Hong Kong Hang Seng Index is a free-float capitalization-weighted index of selection of companies from the Stock Exchange of Hong Kong. Shanghai Stock Exchange Composite is a capitalization-weighted index that tracks the daily price performance of all A-shares and B-shares listed on the Shanghai Stock Exchange. MSCI EAFE Index is a free float-adjusted market capitalization weighted index designed to measure developed market equity performance, excluding the U.S. and Canada. The MSCI Emerging Markets Index is a free float-adjusted market capitalization index that is designed to measure equity market performance of emerging markets. Barclays U.S. Aggregate Bond Index covers the U.S. investment grade fixed rate bond market. The BofA Merrill Lynch 3-Month U.S. Treasury Bill Index is an unmanaged market index of U.S. Treasury securities maturing in 90 days that assumes reinvestment of all income.
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