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Pete Carroll reminded us how easy it is to immediately second-guess our decisions (although he won’t admit that to us on camera). Talk about a guy under fire. While I too am thoroughly disappointed he didn’t go “Beast-mode” (mostly because I wanted to see Brady try to stage a historical comeback with 20 seconds left) I understand he made a calculated decision of which he was very aware would receive major results, or major disappointment.
Isn’t that how we seem to remember our investment decisions as well? What looked like a great investment and a well calculated risk becomes the subject of every conversation where we talk about our regrets and unfortunate decisions. If you’ve been active in the stock market this last month, you undoubtedly experienced these exact emotions. Hopefully this Month In Review will shed light on what may look on the surface like a grim start to the year. As a recap, the S&P 500 and US Aggregate Bond Index had returns of -1.72% and 1.89% respectively for the month of January.
First let’s look at the so-called January effect. The adage says “as January goes, so goes the year.” While we hold to more fundamental and technical analysis as we dissect the markets and economy, this adage has had a very highly predictable result…when January’s have been POSITIVE. When January’s are NEGATIVE? Not so much. Since 1950 when the S&P 500 was positive in January the resulting year’s performance was positive an ASTOUNDING 90% of the time! The average return being 16.9%. However if January was a negative month for the S&P 500 the market followed suite only 56% of the time and over the last 10 years has been only 50%. Where I’m from, a flip of a coin is not a good predictor of market movement. The most prominent examples of January negatives with Calendar Year positives have been 2009, 2010, and most recently (and probably most importantly) last year, when the January negative performance turned into a very strong S&P 500 positive result. And even though a negative January hypothetically creates lower odds that a positive year is in store, it’s all about the vantage point. For instance, every year when the U.S. economy was NOT in a recession, the probability of a positive S&P 500 performance for the year has been 82%! And if you have read our outlook for the year or looked at all the economic leading indicators…nothing is showing that the U.S. is going into recession this year.
So while a choppy and slightly underperforming January may cause many investors to head for the hills, over-turn their wagons and prepare for defense, there is much more to look at in order to decipher what kind of stance is appropriate. Before the year started we predicted that volatility should increase as we head towards the end of the mature economic cycle. So this up and down swinging is not a surprise…in fact it’s rather a long overdue expectation being fulfilled. And while it’s fun to be superstitious about indicators like the January Effect, the Super Bowl indicator, Santa Clause, Groundhog Day, the Chinese New Year, “sell in May” etc., NONE of these are fundamentally sound enough to change someone’s investment strategy and impact their decision-making process.
As far as impactful events that moved the market, January did not disappoint. The most watched news however came from our old stomping grounds…and by old I mean pre-1942. Europe, which has had its share of economic woes over the last 7 years, made some pretty large scale changes to its fiscal policy – specifically the enactment of a Euro QE program much like we experienced in the U.S. after the Great Recession. Mario Draghi, head of the ECB, (which is like saying Janet Yellen of the Federal Reserve) announced a QE program that entails the purchase of public and private sector securities of 60 Billion euros per month (roughly 68 Billion U.S. Dollars) until September 2016. This is a 1.1 Trillion Euro easing program aimed at creating economic activity and combatting the deflation pressure they have had for some time. For you sports fans, this was the same week of the Patriots Deflate-gate scandal…so as you can imagine the financial industry was ripe with deflation jokes and puns. This is just one of many events that have happened which are shaping the global GDP growth for the year. The reason you should be interested in this is because equity markets focus GREATLY on earnings. In fact our consensus of a 5-9% S&P 500 gain this year is all on the backs of earnings (and not valuations). Where does earnings growth come from? Earnings are derived from revenue less whatever costs were incurred to earn that revenue. With labor accounting for more than two-thirds of that cost, global GDP growth plus inflation is a very good representation for global revenue and ultimately global equity markets. This includes the U.S. Markets. In fact 35-40% of all S&P 500 company revenue comes from outside the United States – so what is happening abroad can have a very direct impact on the movement of your personal investments.
One other quick note on the global landscape: emerging markets have been highly depressed in value from the late 2014 energy price slide. Many emerging market countries that are high oil producers (i.e. Russia, Saudi Arabia, Brazil, Mexico, Venezuela and Nigeria) are showing large markdowns in their growth expectations. The drop in these commodity prices have caused there to be a shift in forecasts for GDP across the globe. In fact the only major countries to receive higher adjustments to forecast post the oil-price crash were The United Kingdom, India, and our’s truly (The U.S. in case someone from a different country is reading this); mostly this is due to the consensus that lower energy prices create a stimulus for these specific countries which would become a net positive to GDP. Many other factors like inflation, war, sanctions, weather, secular trends and fiscal/monetary policy play roles in shaping the global landscape. All these come into consideration as we decide how to expose ourselves to the global markets. Okay, so that wasn’t so “quick” of a note.
Here in the U.S. we continue to create jobs. We look for the wage growth to move towards a more normal pace this year as it has been sluggish from the beginning of the recovery. Until we see better wage growth (along with hiring rates and quit rates) we don’t expect the Fed to get anxious about raising rates anytime soon. Our most aggressive stance is that the Fed will begin increasing rates towards the end of this year.
We don’t expect this earnings season to be one to create a lot of optimism, however we don’t think long-term that our earnings reports will negatively impact the U.S. equity market. This quarter’s earnings drag is undoubtedly coming from our overseas revenue. As I mentioned, 35-40% of the S&P 500 revenue comes from overseas. Most of that revenue is in the form of foreign currencies. Last year we experienced a strengthening dollar of which we haven’t seen for a long time. So the profits translate to fewer U.S. dollars creating a drag. Despite the currency hedging, this will no doubt create a drag to our earnings, as we’ve already seen with some big names (Johnsons & Johnson, McD’s, and Oracle).
But fear not. The U.S. is still poised to create more jobs, higher wages, better earnings and more opportunity as we move through the economic and market cycle. As always we are working diligently to make sense of the markets and relate it back to your personal allocations. We are always here to discuss.
The economic forecasts set forth in the article may not develop as predicted and there can be no guarantee that strategies promoted will be successful. Investing involves risk, including the loss of principal.The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.