19 April 2016
What’s Next for the US Market?
A lot of movement, little progress
It was a quarter for the history books, but if one were to just look at the starting and ending point for equities you’d wonder what the fuss was about. We saw ramped up fears of both a global and domestic recession push stocks substantially lower and into correction territory. But on February 11, a rally ensued that brought equities back to within shouting distance of the flat line for the year. Recession fears faded with better data, and sentiment was aided by a dovish Federal Reserve meeting that saw forecasts for rate hikes this year move to two from four. Commodities also staged a nice turnaround, aided by a flattish to slightly weaker U.S. dollar, while oil and stocks continue to trade in pretty tight lockstep.
On to the second quarter
We remain neutral on equities—meaning investors should remain at their long-term equity allocations—and believe 2016 is shaping up to be much like the first quarter, volatile at times but generally trending higher. As long as the oil/stocks correlation remains elevated, continued improvement in the stock market may hinge on the path of oil prices. With oil inventories at historic highs and the ability of oil rigs which have been shuttered to restart in relatively short order, it’s tough to paint a picture of oil moving substantially higher from here over the course of the year. But as we’ve noted before, gross domestic product (GDP) growth has typically been boosted by a fall in oil prices with about a year lag, which could bode well for potential upside surprises in 2016. However, companies remain cautious and apparently reluctant to spend on capital improvements to any great degree. Their preference appears to be adding to the labor force as 215,000 jobs were added during the month of March. The calculation appears to be that given the uncertainty of economic developments, companies believe it’s easier to lay off employees if necessary, rather than trying to get rid of equipment at fire sale prices.
All of this plays into the upcoming earnings season, which is projected to be relatively weak, with another negative growth rate expected. This sets up the potential for upside surprises, but with stocks at what we consider about fair value, stronger earnings are likely needed before stocks can move demonstrably higher. We’ll be watching the reporting season to see whether companies are seeing an uptick in demand and gaining any real measure of pricing power.
We are starting to see signs of inflation ticking higher, which could help companies’ profit margins—although wages are also showing signs of moving higher, with average hourly earnings rising by 2.3% year-over-year in the latest report.
A muddled picture to us…and them
Given this relatively muddied picture with a lot of room for interpretation, it makes sense that the leaders of the Federal Reserve have had some disagreements about the course of monetary policy. Although the last meeting was largely viewed as dovish, with interest rate hike forecasts being reduced and concern over global growth issues being expressed, there was one dissenting vote that preferred a rate hike. That’s only one vote, but after the meeting a couple of Fed presidents have sounded a bit more hawkish than did Chairwoman Yellen did at her press conference following the meeting. In addition, she arguably doubled down in a dovish speech this past week. The April Fed meeting is not off the table for a hike, but June seems more likely. We continue to believe the Federal Open Market Committee (FOMC), in general, wants to get to a more “normal” level of interest rates but that they’ll continue to be cautious about how they go about it. As we’ve shown in the past, historically, stock performed much better when the Fed was moving slowly, as will likely be the case this cycle.
Also a contributor to volatility will be the ramped up rhetoric from both sides of the aisle as we move closer to the November Presidential election. While it may be discouraging at time, resist the urge to think all is lost, or believe those that say it’s never been this bad. So stay calm and until we have the two final candidates—each of whom will have to put forth actual policy proposals—we believe the election will not be a major market volatility contributor.
The first quarter was the proverbial roller coaster, with stocks experiencing extreme volatility, but ultimately ending up back where they started. We continue to believe U.S. stocks are in a secular bull market; but in a more mature phase which will be dotted with volatility and pullbacks. Corporate earnings likely need to recover before stocks can move demonstrably higher. More clarity from the Fed and a better political environment would help, but both seem unlikely in the near term.
This material is issued by Charles Schwab, Hong Kong, Ltd. The information provided here is for general informational purposes only and has not been reviewed by the Securities and Futures Commission in Hong Kong.