February 11, 2016 Was More Important Than November 8
Questions whether the stock market could enter a correction or worse because of Washington, DC’s policy failures seem to totally miss the point that fundamentals were improving long before the presidential election. Certainly, the market’s appreciation accelerated after the election, but few investors seem aware of the improvement in fundamentals and market rotation that occurred more than a year ago. The important date in 2016 for investors was February 11, and not November 8. The stock market bottomed on February 11, and the sectors leading the stock market out of that trough were cyclical. Investment discussions focused solely on Washington, DC seem to ignore that important point. Whether the market enters a correction based on Washington, DC’s failures seems a moot question because virtually no one can consistently time corrections. However, we think the probability of a much more serious bear market is very low regardless of Washington because the underlying US and global fundamentals remain healthy.
Sector leadership after February 11
Charts 1 and 2 demonstrate S&P 500R sector performance before and after the election. Certainly, cyclical performance was obvious after the election, but those sectors’ outperformance actually began nine months before the election. The election has been credited with the outperformance of Financials, but even that group significantly outperformed the market before the election.
Profits cycle once again dominates
February’s cyclical rotation seems attributable to the 4Q15 trough in the profits cycle. 2016 was the year of profits recovery, and history clearly shows that cyclicals tend to outperform during period of profits recoveries. 2016 fits the historical norm.
Chart 3 shows the S&P 500R profits cycle. The trough in the fourth quarter of 2015 and 2016’s profits recovery are clear. By our reckoning, roughly 20% earnings growth seems quite reasonable during 2017.
Stimulus cocktail doesn’t have to be strong
The US economy is normally in a recession when Washington starts mixing policy cocktails of tax cuts, fiscal spending, and deregulation. That is clearly not the case today. Of course, the economy could be stronger, but the fact is the US economy is actually quite healthy.
Because policy makers are starting with a healthy economy, a stimulus cocktail does not have to be very strong to get the economy booming. The risk at this point in the cycle could be that the cocktail is too strong and the economy actually overheats.
Expectations might currently be too optimistic regarding the potential strength of a stimulus cocktail, and short-term disappointment could occur. However, investors need to gauge any program to the health of the current economy. Expectations do not need to be set very high because even a small sip of a stimulus cocktail might produce a booming economy given the economy’s current health.
Bottom line: It’s the bottom line, not Washington that matters
It’s always important to remember that corporate fundamentals and not Washington, DC ultimately dictate the direction of the stock market. Expectations for Washington’s success might be too high, but the reality is that corporate fundamentals remain quite healthy.
That’s why the market troughed on February 11 and not on November 8.
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Hedge Fund Index: HFRI Fund Weighted Composite Index. The HFRI Fund Weighted Composite Index is a global, equal-weighted index of over 2,000 single-manager funds that report to the HFR (Hedge Fund Research) database. Constituent funds report monthly net-of-all-fees performance in USD and have a minimum of $50 million under management or a twelve (12)-month track record of active performance. The Index includes both domestic (US) and offshore funds, and does not include any funds of funds.
3-Mo T-Bills: BofA Merrill Lynch 3-Month US Treasury Bill Index. The BofA Merrill Lynch 3-Month US Treasury Bill Index is comprised of a single issue purchased at the beginning of the month and held for a full month. The Index is rebalanced monthly and the issue selected is the outstanding Treasury Bill that matures closest to, but not beyond, three months from the rebalancing date.
Long-term Treasury Index: BofA Merrill Lynch 15+ Year US Treasury Index. The BofA Merrill Lynch 15+ Year US Treasury Index is an unmanaged index comprised of US Treasury securities, other than inflation-protected securities and STRIPS, with at least $1 billion in outstanding face value and a remaining term to final maturity of at least 15 years.
About Richard Bernstein Advisors
Richard Bernstein Advisors LLC is an independent investment adviser. RBA partners with several firms including Eaton Vance Corporation and First Trust Portfolios LP, and currently has $3.8 billion collectively under management and advisement as of January 31st 2016. RBA acts as sub‐advisor for the Eaton Vance Richard Bernstein Equity Strategy Fund and the Eaton Vance Richard Bernstein All‐Asset Strategy Fund and also offers income and unique theme‐oriented unit trusts through First Trust. RBA is also the index provider for the First Trust RBA American Industrial Renaissance ETF and the First Trust RBA Quality Income ETF. Additionally, RBA runs ETF asset allocation SMA portfolios at UBS, Merrill Lynch, Morgan Stanley Smith Barney, Wells Fargo and on select RIA platforms. RBA’s investment insights as well as further information about the firm and products can be found at www.RBAdvisors.com.
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