Liz Ann Sonders, Charles Schwab & Co’s Senior Vice President and Chief Investment Strategist (meaning: she is the “big cheese” for giving investment and economic analyis) recently wrote an enlightening article which contradicts the doom and gloom, follow the herd mentality we hear from the new media. Her important points are, in summary:
Recent U.S. employment data has renewed the possibility of further Federal Reserve short-term interest rate increases (not decreases as the media would have you believe).
The stock market appears reasonably valued, and higher valuations are unlikely without a return to positive earnings growth.
Some market participants have said low oil prices are sending a recessionary signal, but recessions historically have been preceded by oil price spikes, not crashes(as the media would have you believe).
Most of the time, the U.S. stock market looks to 3 factors (call them the “pillars” which support the stock market) to support its upward trend – let’s grade each of the pillars.
CONSUMER SPENDING: This grade equals B+ (very favorable). Gasoline prices continue to drop. These trends put more money in the pockets of Americans in 2016.
THE FED AND ITS POLICIES: This factor is rated B (favorable). The U.S. economy can handle higher rates as long as the pace of future interest rate increases is slow. Fed Chair Janet Yellen made clear in her press conference after the December meeting that the path higher would be “gradual”.
The Fed’s plan to gradually raise rates in the coming years won’t derail the economy and brings some certainty to the market, says Morningstar’s Bob Johnson. The market consensus on the 2016 pace of increase is somewhere around two to possibly three rate increase of .25% each.
BUSINESS PROFITABILITY: This factor’s grade is a C (average). To date, the earnings reports for the quarter ending 12/31/2015 are mixed because net profits reports show more favorable surprises than disappointments while revenue reports are just the opposite. The bottom line is the data does not support either raising or lowering this factor’s grade at this time.
OTHER CONCERNS: The “Heat Map” is indicating the U.S. stock market is in OK shape ASSUMING no international crisis. On a scale of 1 to 10 with 10 being the highest level of crisis, we rate these international risks collectively as a 7 due to Saudi Arabia severing diplomatic ties with Iran and the potential for social/political upheaval in China. These risks deserve our ongoing attention.
Last week, Bonds increased, but U.S. Stocks and Foreign Stocks declined. During the last 12 months, BONDS outperformed STOCKS.
Returns through 2-12-2016
1-week
Y-T-D
1-Year
3-Years
5-Years
10-Years
Bonds- BarCap Aggregate Index
.2
1.8
1.4
2.3
3.8
4.7
US Stocks-Standard & Poor’s 500
-.7
-8.5
-8.8
9.4
9.3
6.2
Foreign Stocks- MS EAFE Developed Countries
-4.7
-12.9
-16.0
-1.3
0.0
1.2
Source: Morningstar Workstation. Past performance is no guarantee of future results. Indices are unmanaged and cannot be invested into directly. Three, five and ten year returns are annualized excluding dividends.
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“Retirement account reporting – contributions, deductions and distributions”
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Recent U.S. employment data has renewed the possibility of further Federal Reserve short-term interest rate increases.
The stock market appears reasonably valued, and higher valuations are unlikely without a return to positive earnings growth.
Some market participants have said low oil prices are sending a recessionary signal, but recessions historically have been preceded by oil price spikes, not crashes.
Global markets have been unusually volatile so far this year, including during the past few trading sessions. Here is the take on the recent market action and economic news from Liz Ann Sonders, Chief Investment Strategist for Charles Schwab & Co.
The January U.S. employment report came out last Friday. Views on the data were mixed, with some apparently thinking the report renews the possibility of a Federal Reserve rate hike sooner rather than later this year. What was your take?
Liz Ann Sonders: The headline number was weak, but the underlying details were very strong.
The economy created 151,000 jobs in January—below expectations—while revisions shaved 2,000 jobs off the readings for November and December. However, the unemployment rate fell below 5%, a post-recession low, in spite of the fact that the labor force participation rate rose for a third consecutive month.
Household survey employment surged, with 25-to-34-year-olds making up the vast majority of people in new jobs. Part-time workers unable to find full-time work moved back toward a post-recession low. Finally, wages continued to rise, and hours worked were at a post-recession high.
It’s still possible, and some would say likely, that the Fed will not hike rates again in March, but the data renewed the case for continued tightening—likely a primary reason for the market’s slide.
Let’s turn to the U.S. stock market. Technology stocks are getting hit, some say due to steep valuations. What do you think about valuations?
Liz Ann Sonders: There are a wide variety of valuation metrics, often saying conflicting things about whether the market’s reasonably valued or not. My take is the market’s fairly valued, but conditions don’t exist for valuation expansion without stronger earnings growth.
We’re in the midst of earnings season right now, with many companies reporting their financial results for the past quarter. How is it going and what do you expect the rest of the way?
Liz Ann Sonders: The earnings “beat rate”—that is, the number of companies whose reported earnings beat expectations—is currently at 69%, the strongest since the third quarter of 2010. However, the revenue beat rate is still depressed at 46%.1 Materials, technology and health care have had the highest beat rates, with utilities exhibiting the lowest beat rate of the 10 equity sectors.
Over the past four weeks, analysts have raised earnings-per-share forecasts for 347 companies within the S&P Composite 1500® Index, but lowered them for 882 companies—the most negative reading since October 2011.
One important note: Earnings are likely to remain under pressure as long as deflationary winds keep blowing. Pricing power—which, of course, is affected by inflationary or deflationary trends—becomes increasingly important in a slow-growth environment, and one in which labor costs are rising.
Finally, annualized six-month forward earnings expectations for the S&P 500® Index remain in negative territory. This is why you hear talk of an “earnings recession.” What’s import to realize is that earnings recessions often correspond to economic recessions, but not always.
In cases where earnings recessions didn’t correspond to economic recessions, what were some of the common characteristics?
Liz Ann Sonders: The common characteristics of the past four earnings recessions dating back to the mid-1980s that were not accompanied by economic recessions were a surging U.S. dollar and/or plunging oil prices—both of which we’ve experienced recently. Clearly, the energy and manufacturing sectors are hurting, but ultimately the damage there should be offset by the benefit of lower oil prices to the consumption-oriented U.S. economy.
What’s your take on investor sentiment?
Liz Ann Sonders: Not just recently, but over the past several years, the volatility of investor sentiment has generally matched the market’s volatility. Very little movement is needed on the downside, in terms of market performance, to turn sentiment extremely bearish.
One survey I look at is put out by the American Association of Individual Investors (AAII), and that survey recently hit an extreme of low bullishness, while bearishness had spiked. Bullishness, at the recent low, was the lowest since just after the market crash of 1987. Investors are extremely pessimistic—typically, or eventually, a contrarian signal.
You don’t think a recession is on the horizon, but the recession drumbeat is getting louder. What’s behind the noise?
Liz Ann Sonders: Don’t get me wrong—recession risk is elevated, just not glaring yet. Although the U.S. economy remains bifurcated—manufacturing is in recession, but services are hanging in there—talk of recession got louder after the latest reading from the Institute of Supply Management on services came in weaker than expected.
Many suggest the weakness in oil is sending a recession signal. However, it has always been the case historically that spikes in oil prices, not crashes, preceded recessions. It would be unprecedented to have cheaper oil “cause” a recession. The energy and manufacturing sectors have taken it significantly on the chin, but energy sector employment represents only 0.5% of total employment and energy sector capital spending (capex) represents only 4% of total capex. Manufacturing in the aggregate is only 12% of the U.S. economy.
Market-based measures of the economy—for instance, yield spreads, the shape of the yield curve and stock market prices—are sending louder recession signals, while high-frequency economic-data-based leading indicators—like unemployment claims and some housing-based data—are not yet waving a red flag. Overall, the leading economic indicators have not rolled over to the extent typically seen before recessions.
Stocks slipped some 1% last week, but managed to rally from lows, thanks to a late-week rebound in oil prices and Friday’s comments from a Federal Reserve official that bolstered poorly performing bank stocks.
Financials were the second-worst-performing sector for the week, down 2.4%, but did the best Friday, up 4%. Wednesday Fed Chair Janet Yellen played down talk of negative interest rates as only a remote possibility. But investor chatter about it roiled markets, and New York Fed President William Dudley Friday said the debate about negative rates is “extremely premature…The U.S. economy is in quite good shape.”
Investors are antsy over the possibility of a negative-interest-rate policy, something employed in Europe and Japan to encourage growth. But such a program could hurt profits at banks, which would have to pay for reserves they keep at the Fed. A minor recovery in oil prices Friday helped improve investor sentiment, if only for a day. Crude rose 12% Friday to $29.44 per barrel, but was down 5% on the week.
The Dow Jones Industrial Average lost 231 points, or 1.4%, to 15973.84 last week, while the Standard & Poor’s 500 index dropped 15 to 1864.78. On Thursday, both indexes closed at levels not seen since 2014. The Nasdaq fell 0.6%, to 4337.51, for the week.
Thursday, crude received a boost after the United Arab Emirates energy minister said OPEC was ready to cooperate on production cuts, says Jason Ware, chief investment officer at Albion Financial Group. Though low oil prices are good for the global economy, the stock market continues to follow the oil market slavishly, he says.
What’s happening in the real economy isn’t as bad as traders’ screens would have it, he adds, pointing to U.S. January retail sales and weekly jobless claims data out last week that were above consensus.
Brad McMillan, chief investment officer at Commonwealth Financial Network, concurs. The market is slowly coming to terms with the removal of the Fed security blanket—its extraordinary easing policy. “The negative first-quarter earnings seasons is mostly behind us, and it’s gradually sinking in that this isn’t as bad as 2008,” he adds.
Still, the heretofore nonstop fretting in 2016 about Chinese economic growth magically disappeared last week. It might be because Chinese markets were closed last week for the Asian New Year, notes Louie Nguyen, chief investment officer at Soledad Investment Management. “It’s as if the play was missing its main actor,” he says.
When China returns from the wings this week, there could be some volatility if growth slowdown fears return, Nguyen adds. Moreover, on Monday, U.S. markets are closed for Presidents’ Day, and it might not be so relaxing for traders when Chinese markets reopen Sunday evening, U.S. time.
