Monthly Financial Market Update

Monthly Financial Market Update

—February 29, 2016

The summary below is provided for educational purposes only. Given the upswing in market volatility, I am available if you would like to discuss the current market environment and how it may impact your investments.

Seeking Stability

Last month, I maintained there were several things that needed to happen before stocks might stabilize. The list below is not all inclusive but touches on the major themes.

A bottom in oil prices.

Greater stability in the dollar.

Economic data that point to a growing economy.

Some semblance that China is getting its economic house in order.

Index / February Return %* / 2016 YTD Return %
DJIA1 / +0.30 / -5.21
NASDAQ Composite2 / -1.21 / -8.98
S&P 500 Index3 / -0.41 / -5.47
FTSE Developed
ex North America Index4 / -1.99 / -9.18
Bond Yields / Yield* - % a/o Feb 29, 2016 / Yield - % a/o Dec 31, 2015
3-month T-bill / 0.33 Unch / 0.16
2-year Treasury / 0.78 +0.02 / 1.06
10-year Treasury / 1.74 -0.20 / 2.27
30-year Treasury / 2.61 -0.14 / 3.01
Commodities / Feb29 Price, Monthly Change* / Year end 2015
Oil per barrel5 / $33.90 +0.16 / $37.07
Gold per ounce6 / $1,234.90 +123.10 / $1,062.25

Sources: U.S. Treasury, MarketWatch, St. Louis Federal Reserve, CNBC

*Monthly: January 29, 2016 – February29, 2016

Let’s start with point number one. Figure 1 graphically illustrates the close relationship between oil prices and stocks.

Note: Correlation of +1 means the two variables move in lockstep; a correlation of -1 means they move in the opposite direction

Stabilizing or rising oil prices seem likely tosupport stocks. Yet, it seems counterintuitive. The U.S. is an oil importing nation. Every time you or I fill at the pump we save money. It’s like a tax-free raise.

Besides, weren’t we complaining 10 years ago when gasoline prices were hitting $3 and $4 per gallon? It’s really a rhetorical question. We were!

Here’s the problem. The benefits of lower oil prices have been slow to materialize. Though there are indications a shift is occurring, much of the evidence suggests consumers have been saving the windfall at the pump or using it to pay down debt. Long term, that’s a good thing.

However, the collapse in oil prices has forced sharp layoffs and cutbacks in spending by oil companies, without a significant consumer or business response outside the energy industry. Furthermore, loans to the energy patch are getting shaky, which causes lenders to re-evaluate credit standards to both energy and non-energy lenders alike.

Simply put, strong economic headwinds have been met with modest tailwinds.

King Dollar

Moving along, the dollar has rallied over the last year against most currencies. It benefits U.S. travelers when they go abroad, and it reduces the price of imports. But it’s a doubled-edged sword because sales of U.S. corporations around the globe must be translated back into pricier dollars.

End result – sales take a hit, which in turn, cuts into profits. For example, Microsoft (MSFT $51) noted that sales in the quarter just ended were five percentage points lower because of the stronger dollar, and DuPont (DD $61) said sales were eight percentage points lower (Investor Relations) because of the dollar.

Table 1 takes a much broader look at the dollar’s rise, but it also suggests such headwinds will significantly abate in the first quarter.

Table 1: Dollar Headwinds to Corporate Revenue Seem to be Abating

Q1 2015 / Q2 2015 / Q3 2015 / Q4 2015 / Q1 2016
Dollar Headwind* / 18% / 20% / 17% / 12% / 3%

Source: LPL Research, Bloomberg, MarketWatch Date: 2/22/2016

Q1 2016 is an estimate

*Percent change from one-year ago in the dollarversus the currencies of the eurozone, Japan, the U.K., Canada, Sweden, and Switzerland

Of course, the forecast is predicated on how the dollar performs and there are plenty of factors that may influence the greenback, both positively and negatively. But any stability in the dollar would be a plus for the bottom line of major corporations that do a significant portion of their business overseas.

Economic activity rebounds in early 2016

Bear markets, or declines in the major indexes of at least 20%, usually coincide with recessions (St. Louis Federal Reserve). Avoid a recession and we probably avoid a bear market.

Good news – early economic data point to faster economic growth following Q4 2015’s annualized 1.0% increase in Gross Domestic Product (U.S. Bureau of Economic Analysis).

While much can change, the Atlanta Fed’s GDPNow model, which incorporates new economic data as it’s released, is projectinga rise in Q1 GDP of 1.9% (as of March 1). It’s far from impressive but would be a welcome rise following the slowdown at the end of last year.

Bottom line – economic growth aids corporate profits, which in turn lends support to stocks.

China

This one’s a tough nut to crack. The U.S. economy isn’t dependent on China but that hasn’t prevented Asian tremors from rippling up on the shores of U.S. financial markets.

China’s problems won’t be fixed overnight and there has been a healthy debate over whether Chinese policy makers can successfully steer China’s capitalist/communist system.

Eventually, markets may shift their attention away from China.For now, the uptick in the value of the yuan (see Fig. 2) can be viewed as a modest positive for U.S. stocks.

Looking ahead - Brexit

Many of the themes that greeted 2016 are still in place, though some are not as prevalent as they were during January’s dismal performance.

Here’s a new one that popped up on the radar – ‘Brexit.’ It’s a play on ‘Grexit,’ which was defined as the possibility Greece might exit the eurozone, or the 19 nations that use the euro for its currency.

Brexit is defined as the possibility Britain may exit the 28-nation European Union, which is a political and economic alliance that allows member countries to benefit from free trade at the expense of giving up some political authority.

British voters will participate in a June 23 yes-or-no referendum. Polls suggest pro-EU forces are slightly ahead (Intl. Business Times), but there’s plenty of time left and polls have been known to incorrectly gauge sentiment.

Most economists see problems in the short term if Britain leaves the EU, but anti-EU forces believe the removal of burdensome regulations would benefit the nation.

The U.K.’s economy is much more important to Europe than Greece, and we may see added uncertainty if the election appears to be too close to call. If polls start leaning to an exit, expect plenty of negotiations and concessions, as pro-EU forces in Britain and in Europeseek to avoid such an outcome.

Warmest Regards,

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1 The Dow Jones Industrials Average is an unmanaged index of 30 major companies which cannot be invested into directly. Past performance does not guarantee future results.

2 The NASDAQ Composite is an unmanaged index of companies which cannot be invested into directly. Past performance does not guarantee future results.

3 The S&P 500 Index is an unmanaged index of 500 larger companies which cannot be invested into directly. Past performance does not guarantee future results.

4The FTSE Developed ex North America Index is an unmanaged index of large and mid-cap stocks providing coverage of developed markets, excluding the US and Canada. It cannot be invested into directly. Past performance does not guarantee future results.

5 New York Mercantile Exchange front-month contract; Prices can and do vary; past performance does not guarantee future results.

6 London Bullion Market Association; gold fixing pricing;Prices can and do vary; past performance does not guarantee future results.