What a ride!
At times during the 1st Quarter, it seemed as though many investors felt that another recession was already underway. That was reinforced rather strongly by the media—the airwaves were full of recession talk in January and February. Markets reacted accordingly to those fears, as volatility reached levels similar to that of the August-September 2015 correction. To put the volatility into context, there were 61 trading days for the S&P 500 during the 1st Quarter—25 of those days experienced either at least a 1% loss or 1% gain. In other words, about 40% of the trading days in the 1st Quarter were marked by rather substantial stock market volatility.
With that being said, this level of high volatility has really been present since May 2015. Below is a chart that illustrates those levels of volatility over the last 10 months for the Global Stock market as represented by the iShares All Country World Index ETF (ACWI). The index finished the period down approximately 10%, but the striking thing is the movement.
Last quarter, we said that the big European financial conglomerate Societe Generale stated that 2015 proved to be the most difficult year for investors to make money since 1937. For a while it seemed like more of the same for 2016. But, in spite of all the stock market gyrations during this year, markets were able to steady themselves. The broad US stock market (i.e., the S&P 500) finished the 1st Quarter up about 1%. Developed International Markets (i.e., Japan and Europe) finished the quarter down about 1%. Bonds again served as a steadying influence as the US Aggregrate Bond Index was up 3%.
“I Closed My Eyes, What Happened?!”
We all know the feeling when we experience some type of fearful situation. For some it is a scene in a movie. For others it may be a roller coaster ride or being alone in the dark. Many folks have a natural tendency to close their eyes in that moment of terror. In case you had that feeling and closed your eyes when the stock market corrected, we now believe it is safe to open your eyes.
As we have written numerous times over the last year and a half, volatility is more than likely here to stay for the foreseeable future. Volatility in the stock market is not unusual—it has been there since the market’s inception. The difference is now we have CNBC and other financial networks, talk shows, newspapers, and, of course, the internet there to talk nonstop 24/7 about the volatility. They invoke fear and, in this case, started talking about a recession as soon as the market pulled back.
The stock market got interesting on the first trading day of the year. In early January, Chinese officials decided that they wanted to weaken their currency, the Yuan, to help provide some stimulus to their declining economic prospects and manufacturing sector. This event seemed to start serious fears of currency wars and that the world’s second largest economy was going to bring the entire global economy down in an epic collapse that would have been worse than the 2008-2009 financial crisis. The Global Stock Market’s reaction to this fear was to panic and sell almost anything and everything that was not nailed down. At one point, the S&P500 index was down 11% during the quarter.
Eventually, markets began to settle.
So what changed?
Well, some of it was our good ole knights in shining armor: The Central Banks! They are here to save the day again – between continuing to keep interest rates low, take them negative or allowing the US dollar to weaken. Central Banks around the World continue seemingly to be able to fly in at the right moment to institute some new policy or say a few key words and investors move their hands from their eyes and realize the World isn’t coming to an end after all.
The other reality is that investors began to see actual, concrete data suggesting that the probability of a Global Recession had been overblown. As we have mentioned several times, while the US or China is not growing at a rapid pace, growth does exist. In addition, investors saw that, because of the selloff, stocks actually started to look a little cheap again and took advantage of some high quality sectors whose prices were down, in some cases 15-25%.
We would continue to caution that waving the all-clear flag is premature. We still expect an ongoing presence of higher volatility than markets have experienced in the last 3-5 years. It would not be beyond the realm of possibility that sometime later in 2016 another round of significant volatility pops up again.
Ah, the excitement of a roller coaster or a scary movie!
What Do We Expect in the Short Term (3-12 months)?
1. We Continue to Preach The U.S. Economy Does Not Appear to be Trending Toward Recession.
First, for an economy to be in recession, two consecutive declining quarters are necessary. A recession is not a quarter that the economy grew at 0.5%, for example, while the previous quarter grew at 1.0%–it may not be as high as some would like it, but growth by definition is not a recession!
With that in mind, the US economy grew at an annual rate of 1.4% in the Fourth Quarter 2015 and 2.4% in 2015. Granted, that is not the growth rate that we would all like. However, that simply is not a recession regardless how many doomsdayers want you to believe that it is. There are plenty of other economic data points (i.e., hiring, housing, automobile sales, etc.) to suggest that the likelihood of a recession in the US in
2016 continues to be a low probability event. In fact, the recent bleak performance of the manufacturing sector has even started to show signs of improvement in March.
In the absence of a recession, we would continue to place the probability of a Bear Market/Market Crash (i.e., decline of at least 20%) as low.
2. 2016 Presidential Election
We have recently received numerous questions and concerns regarding upcoming market performance since we are in an election year. These questions and concerns are certainly justified, as the last two Presidential elections that resulted in a new President have also coincided with poor market performance. In 2000, the S&P 500 lost 9% and in 2008 the S&P 500 lost 36.5%. Both recent painful experiences that are still fresh on many investors’ minds.
However, over a long period of time (i.e., dating back to 1928), market performance has actually been pretty solid during these periods. Over the last 88 years, Presidential election years (22 instances) have been positive 80% of the time.
At this point, the financial markets seem to be indifferent as to who is winning or losing.
3. Unfortunately More Market Volatility
As we have consistently discussed at length, the stretch from 2012 to mid-2014 was an unusual period where economic data were not very good and US financial markets did not go through a meaningful correction. It would have been highly irregular for markets to continue that trend in perpetuity. The norm is more like what we have seen over the last 18 months.
But, as previously stated, market volatility does not mean that we are definitely headed to a recession or Bear Market (see above). It does mean that simply sitting back and watching markets go up in a straight line is not likely to return in the immediate future.
Periods of volatility can provide opportunity. One of our bedrock foundations is trying to position assets where there appears to be value in high quality assets. This is exactly the tactic that we applied in late January to early February. We cautiously added some high quality holdings to clients’ accounts that we had long watched, and were able to do so at a lower price point. We are not necessarily looking for these positions to turn a massive profit within a matter of days, weeks or months. Rather, we continue to look towards the long term and remain patient..
What Do We Expect Over the Medium Term (12-36 Months)?
1. Federal Reserve Interest Rate Action
We believe that the Federal Reserve is stuck between the proverbial rock and a hard place. The 30,000 foot goal of their actions over the last 6-7 years has been to buy time so that the US economy could get to a place where it could stand on its own two feet. The problem has been that each time the Federal Reserve took an initial step to either curtail its bond purchase programs or raise interest rates, markets freaked out or some other issue popped up around the globe. This means that the Federal Reserve has not been able to replenish its arsenal in a way that they traditionally have, or would like to have, done.
We still think it is plausible that there are two rate hikes still to come in 2016.
2. Continued Economic Expansion
We expect the US economy to continue to expand over the coming quarters. In fact, it would not surprise us to start to see signs of acceleration in the US economy. Two main data points provide us with a level of cautious optimism.
First, core inflation (excludes food and energy) is finally starting to move upward. Kiplinger anticipates core inflation to reach 2% by the end of 2016. Second, wage growth is becoming a reality. Average hourly earnings are up 2.3% over the past 12 months, and during the 1st Quarter, wages grew at an annual rate of 2.7%. As the US economy is increasingly reliant on the service industry, when people have more money to spend, the economy typically grows.
3. Likelihood of Recession/Bear Market Increasing
We will eventually have a recession in the U.S. From where we sit now, we don’t see that in 2016, or even 2017.
Going back to the Presidential Election cycle discussion above, we found that it is actually the year after the election that financial markets can get a little squirrelly. Using the same timeframe of 1928-2015, in the year after the Presidential election, the S&P 500 has been positive only 55% of the time. We aren’t predicting this for 2017, but the data is interesting nonetheless.
The purpose of mentioning this is not to send folks running for the hills, but just as a gentle reminder that recessions and Bear Markets are a part of investing and that another one will come around at some point. In remains prudent to discuss them, as well as to plan for their eventual occurrence.
We believe that the current Bull Market that started in mid-2009 still is intact and has some legs left to run. We expect that there will be more moments of short-term panic than we have seen over the last 3-5 years. We also recommend folks take a good, long hard look at a few realities:
First, most investor’s goals will NOT be accomplished investing in cash and bank-like investments (i.e., CDs, money market accounts, etc.). Interest rates are low and will be low for some time to come—there simply is not enough growth potential to outpace inflation over time. Second, in moving accounts to cash-like investment strategies, we also have to make a decision on when to “get back in”. This decision is substantially more difficult than the decision to “get out”. Unfortunately, none of us have a crystal ball. However, plenty of research has proven time and time again that investors are very emotional creatures who typically make unwise investment timing decisions. Most investors sell towards the bottom and buy around the top—numerous studies have shown that over a long period of time.
We view one of the more important jobs we have in working with clients is to help them avoid that classic trap. It may feel right in the moment, but becomes an extremely slippery slope to navigate. This may not sound exciting, but our best advice right now is to stay PATIENT; do not overract, try not to hang onto every daily market movement, and, above all, remain committed to your long-term goals.
As always, we thank you for your continued confidence and business! If we can answer any questions or provide any further clarification, please do not hesitate to contact us.
We hope that you and your family have a great Spring!
“The Kiplinger Letter”. March 25, 2016. Volume 93, Number 12.
“Don’t Short the Participation Rate”. Brian S. Wesbury and Robert Stein. First Trust. April 4, 2016.