The first quarter of 2016 brought small positive returns in many of the U.S market indexes, which means investors survived – for now, at least – the worst start to a calendar year ever for the U.S. stock market. The Wilshire 5000 Total Market Index (a broad measure of U.S. Stocks) ended the quarter up 1.17% after being down over 10% by the second week of February.
Surely many investors were tempted to bail out when the markets were declining and sit out the widely predicted start of a painful protracted bear market. Some analysts were talking openly about another 2008-9 drop in share prices.
But 10% market declines, known as market corrections, are simply a part of the markets normal turbulence, and anyone who spooks as soon as they see a month of bearish sentiment is likely to miss out on the subsequent gains. Since hitting their 2016 lows on February 11th both the S&P 500 and Nasdaq Composite have gained roughly 13% in value. This is yet another clear example of the dangers of market timing.
“In the short run, the market is a voting machine but in the long run it is a weighing machine.”
- Benjamin Graham
Although in the short run some investors may lose their nerve and flee stocks resulting in price drops, ultimately the value of any company is driven by its profits. Over the long run, the returns on your investments are driven by the millions of workers who grow the value of the companies with their efforts every day. The real value of what you own is driven by the underlying profit that is created in the offices, cubicles and factory floors all over the world, not by how emotionally driven and reactive investors shift with the news of the day.
Today’s Economic Perspective
The Good News
It may not be what you are hearing from news pundits and politicians pandering for your votes, but key data suggests the economy is fairly healthy. Economists anticipate an average +2.4% rate of quarterly Gross Domestic Product (GDP) growth ahead, and with low inflation.
There has been strong growth in personal income, and personal income drives about 68% of GDP. In addition, households are saving more than prior to the 2008-9 crisis. Real purchasing power has been growing steadily. These facts stand in contrast to the common perception that average Americans are going backwards. On the jobs front, America has high job openings, a new low unemployment rate, and record low unemployment claims.
Finally, retail sales, auto sales, and housing starts are all on the rise.
The Bad News
Developing countries continue to struggle as a result of low Chinese demand, low commodity prices, and generally sluggish trade flows. Commodity exporting counties like Brazil, Russia, South Africa, and Venezuela are dealing with intense recessionary conditions.
The effectiveness of monetary policy to stimulate economies is being increasingly questioned, and negative interest rates appear to be backfiring as a strategy.
The U.S presidential campaign will bring uncertainty, and likely cause market volatility this year.
The U.K. referendum on continued membership in the European Union (to be held June 23rd) may create uncertainty and market volatility.
Today’s Market Perspective
\One way of describing the first quarter is “the bear market that wasn’t.” With the market down over 10% before mid-February, not too many investors anticipated a positive return by the end of the quarter. But that’s exactly what happened.
Most market sectors produced slightly positive returns for the quarter:
- Large U.S. companies, as measured by the S&P 500 index posted a gain of 0.77%
- Small U.S. companies, as measured by the Wilshire U.S. Small Cap index produced positive returns of 0.85%
- Bond portfolios, driven by a continued downward drift in interest rates, returned 3.97% as measured by the TUCS Fixed Income index
- Emerging International stocks, as measured by the EAFE EM index, gained 3.97%
- Commodities, which has been a drag on diversified portfolio returns in recent quarters, finally produced a gain of 3.78% as measured by the S&P CSCI index
Global markets, on the other hand are not off to a good start:
- Developed foreign economies lost 3.74% as measured by the EAFE index
- Far Eastern stocks were down 6.06%
- European stocks lost 3.18% for the quarter and are now down over 10% over the last 12 months
Economist attribute the recent market strength in part to the Federal Reserve Board, which had originally signaled that it planned to raise interest rates four times this year. After its most recent meeting, the Fed is projecting just two interest rate hikes this year. Fed Chairwoman Janet Yellen has clearly indicated that the Fed will remain cautious about disrupting the markets and the economy as it unwinds its various Quantitative Easing (QE) initiatives.
Another factor providing tailwinds to the market is the falling dollar. In the first three months of the year, the dollar’s value against a basket of six major currencies fell 4.2%. A weaker dollar makes U.S. exports more price-competitive against goods and services sold in other countries, potentially leading to higher top-line revenues for companies that do business overseas.
The rise of oil, and indications that the Chinese stock market has stabilized, are also helping markets recently.
Looking Ahead
None of this guarantees that there will be gains going forward, however. The Market Watch website reports that half of the S&P 500 sectors are reporting declines in earnings per share this quarter over the same period last year.
But the fear of a recession or a major bear market seem to have eased by recent economic and market events. Earnings (which drive stock prices) may be under some pressure until the global economy reignites, but slow growth is better than no growth and certainly better than negative growth.
Final Thoughts
Recent market history is once again instructive to investors. Q1 2016 results make it clear that acting on predictions of short term market direction is likely to be more damaging than productive.
To succeed as an investor requires patience. Warrant Buffet once observed that the stock market is a superbly efficient mechanism for the transfer of wealth from the impatient to the patient.
Our investment process remains consistent through different markets. It reflects our strong belief in core investment principles. We advocate the benefits of a long-term, broadly diversified investment strategy, and emphasize the importance of aligning your investments with your goals.
By adhering to a disciplined investment strategy, and avoiding the mistakes many investors are tempted to make, we can help increase the probability of achieving your long term investment goals.
Michael G. Donahoe, CFP®, MBA
Principal, Harvest Asset Group, LLC
