The first quarter of 2016 exposed a range of emotions from investors as global equity markets sharply declined in the first half only to recapture much of the losses. The S&P 500 reached a low of -10.3% for the year on February 11th but closed the quarter +1.3%. Similarly, the MSCI Emerging Markets (+5.7% for the quarter) and MSCI EAFE (-3.0% for the quarter) declined significantly in the beginning of the quarter only to rebound subsequently. Through all of the uncertainty and volatility in 2016, consider some of these key market themes:
The Big Three
- China – Slowed growth in China combined with perceived missteps by its key decision makers shocked the global equity markets last August and continue to be a major concern. The transition from a production-based economy to a consumption-based economy has largely contributed to the slowed growth. Concerns over slower demand for commodities, under-regulated banking/debt sector and government manipulated markets and currency are all real. On the bright side, 6.8% GDP growth is still higher than most of the developed world and the growing Chinese consumer is poised to fuel demand domestically and in other economies over time.
- Oil – There has been a lot of political rhetoric coming out of OPEC, Saudi Arabia and others regarding the state of the world oil supply and whether production should be slowed. For the Saudis, there appears to be little incentive to slow production which has major ramifications for the rest of the oil producing countries, including the United States. Lower oil prices have put a lot of pressure on exporting countries as well as many domestic companies and the banks that fund them. Even with the bump to nearly $40/barrel in the first quarter, it is unclear what the floor may be. More interesting is the apparent correlation of oil prices and the equity markets – when should we expect to see corporations and consumers benefiting from such low prices?
- Central Banks – The Fed raised rates in late 2015 with anticipation (er. hope) that they would raise again in 2016. After a tumultuous start to the year, it is looking less likely that another raise will occur in 2016. Around the world, central banks are moving interest rates lower. Both the European Central Bank and the Bank of Japan moved their key interest rates into negative territory. This type of aggressive stimulus is a last ditch effort to spark the economy with unknown effectiveness and consequences.
The Other Key Themes
- Valuations – Public equity valuations in the US continue to be above their long-term averages: S&P 500 forward 12-m P/E ratio is 16.4 as of March 23rd vs. the prior 10-year average of 14.2. This is not necessarily an indication that we will see reversion to the mean, but it has given investors itchy trigger fingers at the first sight of distress. As long as central banks are incentivizing investors to take more risk by keeping interest rates historically low, it is hard to believe that public equities will come out of favor, barring an unknown event. Private technology company valuations have also been put under a lot of pressure, as witnessed by the major markdowns in carrying value for Fidelity's privately-held stock portfolio. Expect to see more headlines on this topic throughout 2016.
- Consumer Sentiment – The University of Michigan Index of Consumer Sentiment declined slightly in March but continues to be historically high. While this on its own may not yield any profound insights, it is interesting in the context of unemployment, wages, offshoring jobs, real estate, taxes, immigration, terrorism, government entitlement programs and consumption. Particularly in this election year, expect to see even more discussion around these topics and how they impact the average consumer.
- Corporate Earnings Expectations – It is apparent that US companies are bracing for a turbulent 2016 and want investors to be prepared. Per Factset, the estimated decline in S&P 500 earnings estimates for the first two quarters of 2016 are 8.7% and 2.4%, respectively. Expectations rise in the second half of the year with earnings growth rates of 3.9% and 9.0% for the third and fourth quarters, respectively.
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