Equities Remain Under Pressure as Investors Focus on the Negatives
U.S. equity prices fell again last week as investors followed the “de-risking” theme that has dominated most of 2016. The S&P 500 Index dropped 3.0% for the week.1 Oil prices staged a slight rebound last week, as expectations rose for coordinated production cuts from OPEC countries and Russia.1 The dollar experienced a sell-off last week as well, which provided some support for the hard-hit commodity-related equity sectors.1 Investor attention remains heavily focused on Federal Reserve policy as market participants scrutinize every economic release and policymaker communication for hints of the timing of the next Fed move.
Key Points
▪ Equity prices are trending down as investors face a host of possible risks.
▪ In our view, there is a disconnect between financial market prices and economic realities.
▪ Volatility and downward price pressures may persist, but equities should outperform bonds over the coming year.
Weekly Top Themes
1. The January payroll report was mixed, but overall pointed to continued economic growth. The headline numbers showed that a less-than-expected 151,000 jobs were created last month, although the unemployment rate fell to 4.9%.2 The report also showed that wages have been accelerating. Average hourly earnings rose 0.5% in January, putting the year-over-year increase at 2.5%.2
2. Corporate profit margins are likely to remain under pressure. Rising wages have the potential to cut into profits. Additionally, productivity measures are weak (productivity fell 3.0% in the fourth quarter).3 Should these trends persist, it would likely create a negative backdrop for corporate profit margins.
3. The energy sector continues to weigh on overall corporate earnings. To date, three quarters of S&P 500 companies have reported fourth quarter results. Revenues are in line with expectations, while earnings are ahead of expectations by 4.5%.4 Earnings per share are on pace to fall 2% for the quarter, although excluding energy, EPS would increase by 4%.4
4. Corporate buyback levels are high, which could be a potentially bullish signal for equities. Through last week, U.S. companies have announced buyback authorizations of $85 billion in 2016, which is the strongest start to a year in history.5
5. The Fed should remain on track to slowly normalize interest rates. Unless market rioting forces the central bank to change its stance, we expect the Fed to stick with its plan to gradually increase rates. At this point, our best estimate is that the next interest rate increase will occur in June.
Stock Prices Should Recover, but it May Take Some Time
So far this year, investors have focused on the negatives and seem to be forecasting a relatively high chance of a U.S. or global recession. Slowing growth in China remains a source of anxiety and could have adverse implications for emerging economies in particular. Wild swings in oil and downward price pressures in commodity markets remain a concern. Investors are also focusing on widening credit spreads, which seem to point to the possibility that tightening credit conditions could put a damper on economic growth. Together, these factors have contributed to a broad risk-off move in financial markets, causing a tough start to the year for equities.
In our view, global economic fundamentals are less dire than market prices imply. It seems to us that investors may be overreacting to fears rather than taking a sober look at fundamentals. We do not believe conditions are in place for a recession in the United States or in the global economy. The U.S. has experienced a moderate economic expansion, and we expect that will continue. Europe should also continue to recover. While Chinese growth is slowing, it remains in positive territory. Falling oil prices remain a risk, but we believe the long-term decline has more to do with oversupply than falling demand.
Nevertheless, investor sentiment has taken a hit and will likely remain negative until we see better economic data from both the U.S. and China, as well as a stabilization in oil prices. We expect these developments will occur over the coming months, but the timing is unclear. When it does become more evident that the economy remains on track, that should pave the way for improved performance from risk assets. We believe equities will outperform bonds over the next six to twelve months. But we also acknowledge that volatility should remain high, and there may additional downward pressure on stock prices in the near term.
1 Source: Morningstar Direct, as of 2/5/16
2 Source: Bureau of Labor Statistics
3 Source: Labor Department
4 Source: FactSet
5 Source: Wall Street Journal
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.
RISKS AND OTHER IMPORTANT CONSIDERATIONS
The views and opinions expressed are for informational and educational purposes only as of the date of writing and may change at any time based on market or other conditions and may not come to pass. This material is not intended to be relied upon as investment advice or recommendations, does not constitute a solicitation to buy or sell securities and should not be considered specific legal, investment or tax advice. The information provided does not take into account the specific objectives, financial situation, or particular needs of any specific person. All investments carry a certain degree of risk and there is no assurance that an investment will provide positive performance over any period of time. Equity investments are subject to market risk or the risk that stocks will decline in response to such factors as adverse company news or industry developments or a general economic decline. Debt or fixed income securities are subject to market risk, credit risk, interest rate risk, call risk, tax risk, political and economic risk, and income risk. As interest rates rise, bond prices fall. Noninvestment-grade bonds involve heightened credit risk, liquidity risk, and potential for default. Foreign investing involves additional risks, including currency fluctuation, political and economic instability, lack of liquidity and differing legal and accounting standards. These risks are magnified in emerging markets. Past performance is no guarantee of future results. CFA® and Chartered Financial Analyst® are registered trademarks owned by CFA Institute.
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