Concerns over a slowdown in Chinese economic growth and plummeting oil prices have been credited with being the major factors contributing towards the dramatic volatility in global stock markets thus far in 2016. I believe that this January selloff, the extent of which has surprised many, appears overdone based upon the following factors.
Stock Market Valuations
After this most recent selloff, the stock market, as measured by the S&P 500 index, could now be described as being fairly valued when compared to longer term, historical averages. While stocks can, and may, become even more attractive from a valuation standpoint in 2016, it would be hard to argue that the market is currently grossly overvalued.
- S&P 500 Current P/E Ratio* = 16.34
(Current Price/Trailing 12 Months Earnings)
- S&P 500 Forward P/E Ratio* = 13.20
(Current Price/Estimated Earnings for Next Year)
- S&P 500 Historical P/E Ratio (25 years)* = 16.67
*All data provided by Bloomberg as of January 20, 2016.
Global developed market economies, while not knocking the cover off the ball by any means, are projected to experience further growth in 2016. Additionally, those concerned with the impact of low oil prices on economic growth in the U.S. should remember that 70% of economic growth, as measured by Gross Domestic Product, comes from consumer spending and lower oil prices (which are likely to move even lower over the short term), while having a negative impact on the Energy sector, can have a positive impact on the purchasing power of the consumer. Of course, China’s slowing economy and its impact on global economic growth remains as a concern and I will continue to pay attention to the success of the Chinese government in promoting future economic growth, or perhaps preventing further declines, in their homeland.
According to the 2016 Global Outlook from The Conference Board:
- Economic growth in the U.S. is forecasted to grow at 2.4% in 2016, a slight decline from the 2.5% actual growth of 2015.
- Economic growth in Europe is forecasted to grow at 1.8% in 2016, a slight increase from the 1.7% actual growth of 2015.
- Economic growth in Japan is forecasted to grow at 1.2% in 2016, a relatively significant increase from the 0.6% actual growth of 2015.
While the housing recovery trend weakened heading into the close of 2015, I still believe that there are not currently any substantial risks to the downside for the housing market and our outlook remains positive for the housing market over the short-intermediate term as the U.S. economy continues to stabilize and the Fed continues to progress upon a gradual, longer term tightening cycle.
- According to MarketWatch, U.S. housing starts climbed 10.8% in 2015, with building permits increasing by 12%.
Data provided by the National Association of Realtors, as of November 2015, shows that:
- In terms of sales volume, existing home sales continue to struggle in the lower price ranges but are displaying signs of continued strength in the vast majority of the mid-higher price ranges in all regions of the United States.Sales prices turned in positive results on a year-over-year basis across all regions of the country through November of 2015.
- Overall, across the U.S., the median sales price of existing single-family homes rose by over 6% versus November 2014, with the largest increase of over 8% interestingly taking place in the West region.
I believe that the employment picture looks relatively strong in the U.S. but continued new job creations, as well as continued improvements in wages and labor force participation, are critical ingredients for the sustainability of the economic recovery in the United States.
- The “official” U3 unemployment rate fell by more than 11% over 2015 to its current level of 5.0% as of December 2015. More importantly, the unemployment rate has remained below the previously communicated Federal Reserve target threshold of 6.5% for 21 consecutive months. As you may recall, an unemployment rate of 6.5% was the level where the Fed had indicated that they would feel comfortable considering an initial interest rate hike.
- Following a relatively similar path, the more encompassing U6 unemployment rate fell by more than 12% over the past year from 11.2% as of December 2014 to its current level of 9.9% as of December 2015.
- While jobless claims did spike up during various periods 2015, catapulting above 320,000 claims at one point, the most recent reading on January 2, 2016, came in at 277,000 initial jobless claims. This represents a 7% since the end of last year.
Now that market participants have moved past speculating about the timing of the initial interest rate hike by the Fed, most are now turning their attention to market fundamentals, such as earnings, and earnings growth potential is projected to be strong for 2016, coming off of a lackluster 2015.
According to the January 15, 2016 FactSet Earning Insight report:
- With 6% of the companies in the S&P 500 reporting earnings to date for Q4 2015, 78% have reported earnings above the mean estimate and 47% have reported sales above the mean estimate. Some of the noteworthy names that have beaten estimates thus far include Intel, Netflix and JP Morgan.
- For all of 2016, analysts are projecting earnings and revenues to increase on year-over-year basis by 6.7% and 3.9% respectively. Compare this to analyst projections of earnings and revenues declines of 0.8% and 3.4% respectively in 2015 on a year-over-year basis, led lower by companies in the Energy sector.
Central Bank Activism
Many Central Banks around the world have indicated that they remain armed and ready to help stimulate growth in their respective economies in the New Year through interest rates cuts (or lack of additional interest rate hikes) and/or their own forms of quantitative easing. Any such announcements from central banks, including the U.S. Federal Reserve and the European Central Bank, can help to ease the fears of worried investors and provide for stock market rallies, though likely short term in nature.
I am not suggesting that this selloff does not have any additional legs, nor that this may be the only selloff of the year, as volatility may very well be the story of 2016. I do, however, think that investors should put all of this volatility into the context of current economic and market fundamentalsdiscussed above prior to making any shortsighted investment decisions.
This volatility also serves as an important reminder to investors in terms of the importance of asset allocation in their portfolio strategies. In our view, portfolio strategies should always be constructed in accordance with one’s investment objectives, investment timeframe and tolerance for risk. While past performance cannot guarantee future results, and asset allocation cannot ensure a profit or protect against a loss, applying a historical perspective and maintaining an appropriate strategic asset allocation can help provide comfort and direction to investors during periods of great volatility, such as the period we are experiencing to start the new year.