This week Wall Street Traders are all back from their holiday vacations and setting the tone for the market. In the first few days of trading it has been a confusing tone, with the market selling off significantly in the new year, seeing a huge 3-day drop in the market.
So what’s going on?
The underlying fundamentals of the economy still appear strong. The U.S. economy continues to grow at a pace of 3-5%. The U.S. continues to have one of the best economies in the world right now on a relative basis. This continues to bode well for corporate earnings and U.S. stocks. On the flip side, it is also creating a strong dollar. That may not be good for large cap companies with a lot of foreign sales.
The interest rate environment remains favorable for both U.S. stocks and bonds. I continue to believe there appears to be more capital appreciation potential in stocks than in bonds however. It will take extreme geopolitical events to create a huge flight to safety into bonds, so their potential for appreciation this year seems limited.
It is almost a certainty that the Fed will finally begin raising interest rates after six years of zero interest rate policy. The market has already baked a rate hike into the market. But for now, the Fed remains patient in case the global economy continues to deteriorate.
The jobs picture also remains favorable. Initial jobless claims continue to come in at under 300k. The unemployment rate currently stands at 5.8%. Compare that to the double digit rates in Europe. The European economy has a long way to go. Inflation in the U.S. remains tame. Russia by contrast is running at about 11% as their currency remains under extreme pressure.
From a valuation standpoint, the market is trading at around 17-18 times forward earnings. While this is not cheap, it is sustainable give the fact that the long-term average for the market is around 16-17 times. To put the market valuation in further perspective, during the extreme bull market run of 1999-2000, the PE was running at 30 times for the S&P 500 and 100 times for the NASDAQ. No wonder, even fifteen years later, the NASDAQ is still not back to its record levels!
So with all the things going for the market, why are we seeing this big sell-off and what does that mean for the rest of the year? There is the trading adage, “so goes January, so goes the rest of the year.”
The biggest reason for the market decline is the plunging price of oil. Shouldn’t that be a positive tailwind for the economy, especially the consumer sector? But oil prices are now below $50 per barrel and they have yet to find a floor. This is unsettling for many investors and fueling much of the negative sentiment.
The 10-year bond yield has dipped below 2% to the lowest level since October. There appears to be some flight out of stocks into bonds on the negative oil sentiment. And Financials are also trading down as investor hopes for a steeper yield curve have been, at least temporarily, thwarted.
The market was also spooked by some negative economic data. The Institute for Supply Management’s non-manufacturing index declined to 56.2 last month from 59.3 in November. And factory orders were also down in November.
I remain diligent and I am keeping my eye on the situation, but at this point I think that the positive underlying fundamentals will win the day and slow global growth and an oil market that has yet to hit bottom will not wake up the sleeping bear here in the U.S.
And one more item of note. Looking back to the beginning of last year, the market got off to a similar start. So rather than forecasting gloom and doom for the rest of the year, I remain focused on the facts I know and for now, the facts and the recent sell-off don’t really line up.
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