The quick and decisive pullback in stocks last mid-week was hardly unexpected. As we wrote previously, we would not have been surprised... and felt the Relative Strength Integers (RSI) were suggesting.....that a correction was due at the conclusion of consecutive weeks of intense buying. Several sectors have run significantly in the last month, making it a distinct possibility that earnings expansion this season won't keep pace with price acceleration. As earnings-driven investors, we are always attuned to the velocity of or changes in the bottom-line potential of publicly traded companies. Despite low interest rates and a lack of suitable investment alternatives to stocks, we still cannot foresee "straight line" (linear) price movement in stocks indefinitely.
On
the subject of rates, however, we do believe that there must ultimately be
homage to an improving US and global economy through upward interest rate machinations
by the Federal Reserve and other global central banks. Quantitative easing in nations like Japan and
Italy has not yet produced a desired economic stimulus. Those models will probably be altered if the
outcomes don't improve.
The
main problem in 2016 with a protracted policy of easing borrowing expenses is
that the policy itself has not produced the empirical results observers had
expected. While we do acknowledge that
cash infusion definitely averted an economic calamity at the beginning of the
recession (2008-2009), the effect of maintaining such a bias in the middle of
this recovery has created other, inadvertent consequences, not the least of
which is failing to give savers and responsible investors a fair return on
their cash deposits.
Additionally,
global governments have been "toying around the edges" with their own
monetary policy by using rate cuts to create trade advantages against other
nations by devaluing their currencies in hopes of stimulating demand for their
products. This "race to the
bottom" of the yield curve produces very few winners in the end.
So,
while global stock markets rally from the effects of austerity and quantitative
easing, the net result is slower activity and a harvest of potentially weaker
earnings data. We see a major
reassessment of asset prices in the offing.
There is no need for the Federal
Reserve to continue playing with emergency measures targeted at inflation and
unemployment. It would go a long way,
and deliver a powerful message of confidence, if the Fed raised rates sooner
rather than later.
A
little of that....
It
is curious, also, that the Fed signaled bullishness about the US economy when,
last December, they actually did move to change interest rate policy. In the past few weeks, earnings reports have
been indicating "slacking" profit acceleration, even though well
above recession lows. Increasing wage
levels are good for employees, moderately painful to the corporate bottom
line. I'm sure the Fed will keep a close
eye on labor and employment data to maintain a balance between cost expansion
and net revenue growth.
Continuing
volatility in oil prices has hurt the energy complex, as well as the banks and
investors who lend to them. As
production and capacity expanded during the recovery, prices for the commodity
had fallen to generational nadirs. Almost
as quickly, prices at the pump have recently begun an upward trajectory. The year ahead probably offers more of the
same back-and-forth. The risk of
deflation/inflation in energy, and other commodities, is yet another barrier to
the markets' capital gains potential.
There
are other, less obvious risks to market expansion, such as terrorism, domestic
politics, war, or any other geopolitical event which might negatively exacerbate
consumer confidence or consumer's financial discomfort. Our point is that there are always two sides
to every story...in this case bull or bear....and there is ample justification
for one point of view, the other, or just resolute ambiguity.
As
we lurch towards the midpoint of this quarter, we feel the greatest risk to
financial assets is not necessarily what can be described in a textbook or by financial or economic
language, but in the potential for consumer's
psychological vitality simply to dissipate, like an ember fading away.
Slow
deaths might be less dramatic, but are nonetheless just as painful.
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