It is easy to forget that newspapers and television live on sensationalism.
The more sensational the headline, the more newspapers will sell. Boston Business Journal recently released an article entitled, "Boston's Economic Forecast: Trouble on the Horizon." If their headline was instead, “Ignore the pundits, things are basically OK," they’d probably sell fewer newspapers.
Our advice when there is “Trouble on the Horizon,” from an investment point of view, is to ignore the headline and look into the premise behind it. Often, ignoring the hype is the right long term investment decision.
We agree with the sentiment quoted, “A recent report … rated the chances of a 2016 U.S. recession as “reasonably low,” though … economic data pointed to “a somewhat fragile future” for the national economy, as suggested by the weak fourth-quarter GDP”. There is a possibility of recession (there is always the possibility of recession) but the probability is reasonably low.
As far as Greater Boston, the major industries of education and healthcare are largely impervious to economic downturn. Financial services, real estate, bio-tech and venture capital may be subject to recessionary pressures, but high talent human capital can often offset cyclical economic forces. In the longer term, Greater Boston’s attractions as a world class city with world class facilities, universities and hospitals point to further population growth and increased tourism. As Boston goes, so goes Massachusetts, so we think the Massachusetts economy will continue to grow slowly over time.
With regard to equity markets, past experience helps us to frame our understanding of the future. For example, the average market correction since December 1949 is -14% with the average correction lasting 120 days. The average gain following a market correction is 47% (median gain is 32%) lasting an average of 495 days. From peak (July 20, 2015) to trough (February 10, 2016), the S&P 500 was off -12.1% on a total return basis. Since February 10, the S&P 500 has returned + 9.5% through last Friday. Year to date, the S&P 500 is off -0.5%. (See chart below)
The year began poorly with market fears related to the continued drop in oil prices, slowing growth in China and the strong dollar. This created uncertainty in the short term which fed negative investor sentiment and poor equity market returns. We expect continued uncertainty related to the US election, emerging market currencies, the direction of oil and the dollar and liquidity concerns in low-grade segments of the bond market. However, a good earnings season, lower PE valuation ratios and the long term positive impact of low oil prices may offset these fears in 2016, leading to low single digit equity returns in 2016, albeit with a lot of volatility and uncertainty.
There is uncertainty as to the direction of overseas economies and markets. When oil prices plunged below $30 to the lowest level in twelve years in February, fears of contagion spread into the energy, materials and financial sectors. Global deflationary fears are a concern to central bankers with negative interest rates in Japan, Denmark, Switzerland and Sweden. In the US, the fear is the opposite, that the Fed will raise rates over the next two years. This divergence in foreign monetary policy from US policy is causing disruption in currency markets. Add geo-political uncertainty and we get a flight from investment risk.
The major drivers of equity returns are the state of the economy, the actions of the central banks, company fundamentals and valuations. The US economy is still growing in the low 2%s annually, despite a slowdown in the fourth quarter. Ex-US central bank actions remain accommodative, which are net positive for stock appreciation and global liquidity. Earnings weakened in the fourth quarter, particularly in the energy sector but most analysts still believe that earnings growth will be forthcoming and thus far in the quarter, company earnings have been at or above estimates. This leaves us with valuation, or investor sentiment. At year end, forward PE was at 16.1 times earnings versus the 20-year average of 17.2 times earnings. Valuations are not stretched at this juncture, but on the other hand, equity risk seems to be increasing which might justify a lower PE.
While we are not certain of the current direction of markets, we do have confidence that well-diversified portfolios should give us opportunity for gain while limiting exposure to losses. There is a chance that the market forces evident in January and early February will return and continue a long stretch of negative returns, beginning last August, such as we saw from 2001 to 2003. Today, the market forces are more positive and being driven by earnings, improved investor sentiment and higher oil process. Our most likely scenario is that the US equity market recovers to low single digit returns by year end.
- Matthew V. Pierce, Chief Investment Strategist
*This content is developed from sources believed to be providing accurate information. The information provided is not written or intended as tax or legal advice and may not be relied on for purposes of avoiding any Federal tax penalties. Individuals are encouraged to seek advice from their own tax or legal counsel. Individuals involved in the estate planning process should work with an estate planning team, including their own personal legal or tax counsel. Neither the information presented nor any opinion expressed constitutes a representation by us of a specific investment or the purchase or sale of any securities. Asset allocation and diversification do not ensure a profit or protect against loss in declining markets. This material was developed and produced by Advisor Websites to provide information on a topic that may be of interest.