2016 has been a big disappointment for stock investors. A cratering crude price spooked many, falling 18% in January, following December’s 15% dive. A tone deaf Federal Reserve also weighed.
Markets Rebound Mid February
However, there are now plenty of reasons for a constructive take on the outlook. With the markets down 10% in early February, investor sentiment turned bullish. The all-important crude price soared 45% in four weeks, leading a charge back into risk assets including stocks.
Concerns about a US recession receded as labor market strength continued amid generally constructive data points on the US economy. Global markets were heartened by continued efforts by central banks worldwide to do what it takes to offset deflation.
The International Energy Agency upgraded its view on the direction of crude oil prices, opining that fossil fuel prices may have bottomed out. It cited supply disruptions in Nigeria and Iraq, increasing likelihood that producers could maintain a production freeze, and reduced production in the Americas.
Low interest rates continue to provide a tail wind. With the ten year Treasury yielding over 30 basis points less than the S&P 500, yield starved investors are embracing stocks. Stocks’ payout typically rises 5 to 6% annually, making for a strong likelihood of a superior total return versus fixed income over a reasonable period of time.
Near Term Risks Still Abound
With nearly 30% of economies around the world now subject to negative interest rates, skeptics scoff that the ever lower rates are having decreasing stimulative effect, with serious negative collateral consequences. However, on balance the problems of super low interest rates seem to pale compared to excessively high interest rates, particularly in a deflationary world.
Stock valuations are certainly no bargain, with the S&P generally trading at 17 times projected ’16 earnings, not historically cheap. Yet, it’s difficult to call a market overpriced with such a large yield advantage over the 10 year Treasury. Admittedly, that yield advantage disappears when compared to the relatively elevated yield of corporate bonds; the Dow Jones Corporate Bond Index yields 3.2%, a 1% premium to the S&P 500’s 2.3%.
The earnings recession continues, meaning negative year over year profit growth. Stock price growth is dependent on earnings growth. However, some of the key profit headwinds, like low energy prices and a strong Dollar, show signs of abating.
Fish in These Sectors
The 2016 volatility has created several attractive sectors. Financials are down nearly 10% amid recession fears, talk of negative yields compressing margins, and possible defaults among energy borrowers. However, this has produced even more attractive valuations in a group that never truly recovered from the subprime meltdown. The fundamental outlook will improve with a strengthening economy and potentially rising interest rates.
Industrials, classic cyclical plays, offer good value after being sold off last year on the back of a strong Dollar making US made goods less competitive, global recession fears, and declining orders from energy related companies. However, generally low energy prices reduce costs, providing a tailwind for profitability.
The handwringing continues over energy concerns. Is slowing global growth crimping demand, leading to ultra-low prices? Or is supply glut the culprit, as new drilling technologies in the West, coupled with new supply from Libya and Iran, depress prices?
While it’s probably a little bit of both, we do know that the best cure for low prices is low prices, as supply is curtailed quickly under the unprofitable conditions. Indeed, we have seen drilling down by over 50% in North America, while the second straight year of reduced capital expenditures, not seen before in modern times, lays the groundwork for firmer prices.
Energy investors’ investment risk is reduced by the low share prices now prevailing, now off 30% or more from recent highs.
Thank this year’s bumpy start for financial markets for producing a host of blue chips selling at bargain levels.
Note: David G. Dietze, JD, CFA, CFPTM is President and Chief Investment Strategist of Point View Wealth Management, Inc., a registered investment advisor at 382 Springfield Avenue, Summit. CNBC has named Point View to its list of the top 100 American fee-only wealth managers for both 2014 and 2015! The full-length version ofthisarticleisavailableat: www.ptview.com.
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