“What…me worry?” Alfred E. Neuman, MAD magazine mascot
As we enter the final quarter of 2016, investors find themselves in an unusual position: a strong Q3 has pushed all major asset classes into the black for the year thus far. The last time this happened was in 2010, the first full year of recovery from the Financial Crisis. This year, markets reacted to increasing geopolitical tensions, a contentious U.S. election cycle, turmoil in the oil patch, a possible rate increase by the Fed and future dollar strength by…climbing higher. Given that there are always things to wait on and worry about in the markets, Alfred E. Neuman is our spiritual guide this quarter.
In the 3rd quarter, oil and commodity prices corrected, U.S. real estate cooled, but smaller-cap and international stocks had very strong returns. Here’s a summary table of market results:
Most investors have heard mention of the markets’ ‘wall of worry.’ It is built, brick by brick, of all the issues that are believed to give investors pause, particularly with respect to equities. Here’s one rendition of the wall as perhaps imagined by Pink Floyd:
“So we keep waiting / Waiting on the world to change” John Mayer, Waiting on the World to Change
Here’s a brief summary of what we think investors are waiting on now:
Global Growth: Expectations are still low and slow. The OECD’s September 2016 projections are for World GDP to dip to 2.9% in 2016 and hit 3.2% in 2017. Over those years, the U.S. is projected to grow 1.4% and 2.1%, and the Euro area 1.5% and 1.4%. China is expected to drop to 6.5% and 6.2%. Recessions are not imminent. Both the European Central Bank and the Fed are paused in their rate-management regimes, but a survey of the globe’s interest rates indicates that monetary policy effectiveness appears to be exhausted. Fiscal spending is the other growth tool, and the time has come for governments and corporations to increase spending. With unemployment averaging over 10% in the Euro area, a strong impetus is necessary to get growth back on track in countries other than Germany.
The Fed’s interest-rate hikes: The world anxiously awaits the Fed’s next move. We now fully understand the Fed is ‘data-dependent’ and is reviewing every data point they can. Their delays have promoted a false ‘floor’ to the markets as a result. Reviewing the changes from June (purple) to September (green) 2016, the Fed members’ dot plot of future rate expectations indicates a ‘lower and slower’ level of increases over 2017 and 2018.
U.S. stock earnings: One ‘brick’ in the wall that we’re focusing on is the next four quarters of S&P 500 earnings results. Technically, the market has been in an earnings recession for several quarters; forward expectations are for strong comparisons beginning with Q4-16 earnings. Energy sector comparisons in particular are expected to be favorable, but any earnings shortfall might promote a market correction. Here is one snapshot of current earnings expectations:
Geopolitics: Reaction to the current state of global affairs is, frankly, surprising. We have many regional conflicts in the Middle East, rising terrorist threats in Western countries, nascent muscle-flexing by Russia and China, a seeming break in relations between the U.S. and the Philippines, elections with populist overtones in the U.S., France, the Netherlands, Italy and Germany over the next 18 months, a failed coup in Turkey, economic and political upheaval in South America…suffice to say, the list is large. Underpinning these external concerns are the gyrations in the energy and metals markets, and China’s economic transition. We would normally expect more market downside volatility surrounding these events and uncertainties, which leads us to believe investors are waiting for some lynchpin event – an election or other change – that may push market direction more firmly. What we’d like to see is stability and clarity in government control, planning and policy execution, with a de-emphasis on fringe groups and their political agendas. A resolution of the long-running issues in the Middle East would go a long way to promoting this stability.
“Don’t you worry ‘bout a thing…” Stevie Wonder, Don’t You Worry ‘Bout a Thing
Investors worry; it’s our perpetual state of mind in which all news has a downside. Investors also have much to be cheered by in the years since the Financial Crisis. Broadly speaking, the U.S. has recovered well, and other developed nations have recovered to a lesser degree. Globally, however, we find ourselves at another inflection point. New growth-oriented political and fiscal solutions are on the table, and careful management of these policies to promote growth is vitally important. A return to ‘normal’ interest rates, capital-raising policies and asset valuations would be welcome. As we approach the U.S. elections, we need to be mindful that, once they’re concluded, we will still have a functioning global economy and governments. New agendas will be in place, and markets will have a ‘certainty point’ to begin assessing policy changes and their potential impacts. This implies higher short-term volatility, but we’ll maintain our faith in capitalism, our long-term optimism and commitment to diversification as the best solutions to manage through these intriguing times.
As always, we welcome your comments and questions.
–Your Wealth Management Team at JJ Burns & Company
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