April 1, 2016
RECAP OF THE FIRST QUARTER
From an economic and geopolitical perspective, the first several weeks of 2016 were bleak enough to make even the most intrepid investors shudder as the following events unfolded:
- Jan. 2: Tensions between Saudi Arabia and Iran soared as the Saudis executed 47 dissidents, including Nimr al-Nimr, a prominent Shiite cleric.
- Jan. 5: North Korea detonated what it claimed to be its first-ever hydrogen bomb.
- Jan. 7: China’s control-minded central bank allowed the biggest drop in the yuan in five months, roiling global markets and sparking new fears about Asia’s largest economy. Trading in the country’s stock markets was suspended for the day after only 29 minutes.
- Jan. 25: China’s capital outflows were reported as jumping to $159 billion in December and to almost $1 trillion for 2015 as a whole, stoking fears of additional devaluations of the yuan and the start of a new global currency war.
- Jan. 29: U.S. GDP growth for Q4 2015 was reported at an anemic, below- consensus level of 0.7%, increasing concerns of the U.S. falling back into a recession.
- Jan. 29: The Bank of Japan adopted negative interest rates for bank deposits held at its central bank. It was meant to stimulate bank lending but backfired as earnings expectations for banks tumbled and Japanese consumers began to literally hoard cash.
- Feb. 8: Deutsche Bank stock fell to an all-time low as credit concerns over its ability to cover interest payments on its bond obligations intensified, sparking a sell-off in European bank stocks as a whole.
- Feb. 11: At a scheduled news conference, Federal Reserve chairperson Janet Yellen indicated that negative interest rates are possible in the U.S. and that “We’re taking a look at them . . . I wouldn’t take those off the table.” Stocks retreated, especially bank stocks.
- Feb. 11: After the stock market closed, it was reported that Jamie Dimon, CEO of JP Morgan Chase, bought $26.6 million of JP Morgan stock with his own money, helping to abort a “mini-run” on bank stocks that had been developing.
- Feb. 12: Deutsche Bank repurchased $5.4 billion of its own debt obligations as a sign of its strong capital position and solvency. The firm’s stock jumped by 12%.
- Feb. 12: During a scheduled speech and after seeing the prior day’s market response to the possibility of NIRP (negative interest rate policy), New York Federal Reserve President William Dudley downplayed its role and the prospect of such an event occurring in the U.S.
- Feb. 26: Rhetoric and currency intervention following the G20 Summit in Shanghai suggested that a Plaza Accord1-like agreement was reached during the meetings, reducing upward pressure on the U.S. dollar and downside pressure on the Chinese yuan.
- Mar. 10: European Central Bank President Mario Draghi announced an update to the bank’s stimulus program, with additional cuts to both deposit rates and bank refinancing rates. The ECB’s quantitative easing (QE) program was also increased from 60 billion euro in bond purchases per month to 80 billion and included corporate bonds as purchase candidates. Interest rates fell on a global basis.
- Mar. 11: Oil service company Baker Hughes reported that active oil rigs fell to 386 (from a peak of 1,609 in 2014), the lowest level since 2009. Oil prices continued their advance, anticipating further cuts in production/supply.
- Mar. 29: At her speech at the Economic Club of New York, Janet Yellen delivered a dovish message to the public, stressing that the Fed intended to “proceed cautiously” with regard to rate hikes as global developments (China, oil) continued to “pose ongoing risks” to growth. Fed fund future contracts all but eliminated the chance of a Fed rate hike in April.
Not surprisingly, the markets responded to the “knee-jerk” news events in similar fashion with most asset classes posting strong rebounds off of their intra-quarter lows by the time the period had ended (Chart 1), and stock markets reversed from their troughs in almost perfect unison (Chart 2).
Since last fall, the S&P 500 has been trading almost in lock-step fashion with the Citigroup Economic Surprise Index (CESI, Chart 3). This index is a running tally of U.S. economic releases, recording whether each report meets, beats, or lags the corresponding consensus estimate for the series. A CESI figure greater than zero indicates that collectively the economy is doing better than estimates; below zero, worse than expected.
The S&P troughed on February 11th; the CESI had bottomed on February 4th and began showing an improvement in the U.S. economy from that point on. Emerging market stocks traced a similar pattern to the S&P during the quarter but with a rebound in oil prices as the primary driver (Chart 4).
Additional cuts in oil production are anticipated (Chart 5), which should lead to a further firming of oil prices, benefiting energy companies and their earnings prospects. Many industry analysts now believe that oil prices have found a bottom, though the trek to higher prices may be an arduous process, as oil inventories are at multi-decade highs and will require a steady increase in demand to whittle down existing stocks (Chart 6).
With the Fed indicating a more dovish approach to potential rate hikes, the dollar has stopped advancing and has actually weakened versus many currencies. However, dollar strength is not a forgone conclusion when the Fed raises rates. The last four times the Fed has embarked on a tightening cycle, the dollar has been stronger one year later on two occasions, and weaker twice (Chart 7).
As we are in the midst of an election year, investors should expect additional market volatility to unfold as they grapple with the uncertainty of whom the final two candidates will be and which candidate will ultimately prevail. Historically, the stock market has followed that type of pattern during election years (Chart 8).
Although this year could certainly be different, election years have generally been good to the stock market, with the S&P 500 advancing in fourteen out of eighteen election years since 1944, with an average return of 6.5%.
Let’s keep our fingers crossed.
We anticipate no major changes to portfolio allocations in the foreseeable future, preferring stocks over bonds and an almost equal balance between domestic and international securities within each asset class.
Source: Bloomberg, Fiduciary Trust