Mid-Quarter Update: Stocks Treading Water
May 20, 2016
After recovering strongly from the 10% decline that occurred in the first six weeks of 2016 and vaulting to reach their high point for the year in April, U.S. stocks have drifted lower in recent weeks.
Oil prices have bounced significantly in the last several months, rising from their lows of $31 per barrel in January to $47 at present. This helped the energy sector regain a little lost ground. However, first quarter corporate earnings reports released in April and May have left a lot to be desired—particularly from the technology and retail sectors. Many companies offered up uninspiring guidance for the rest of 2016, and their stocks sold off accordingly. The S&P 500 Index reached its 2016 high (so far) on April 20th and has backed off by about 3% since then. As of today, it is down a fraction of a percent for the year.
Sideways is better than down, of course, but it is no fun for investors (or for me) when markets move sideways for an extended period while being occasionally interrupted by sharp downdrafts, as they were in August of 2015 and January/February of this year. During such times, investors should reacquaint themselves with the reality of equity market returns in a given year: they are often very different from the average annual returns that stocks have generated from 1928 to 2015 – which is about 10% in nominal terms and 7% in real terms (net of inflation). In fact, returns in a given calendar year are rarely average.
From 1928 to 2015, calendar-year returns from U.S. stocks were only near (plus or minus 2%) the long-term average of 10% in only 3 cases out of the entire 87-year sample! The highest calendar year gain was scored in 1954 (52.5%) and the biggest decline was suffered in 1931 (-43.8%). To summarize, calendar year stock returns are all over the map. Investors should understand the limited utility of holding convictions about what stocks will do in any given year. The longer investors hold stocks, and the more economic cycles they see (endure), the more likely they are to realize returns that approximate the attractive long-term average.
In the past few weeks investors have some good news and some bad news. In fact, it was the same news: several economic reports have indicated that the U.S. economy continues to improve. For most people this is unequivocally good news. For investors, however, the growing strength in the economy portends higher interest rates, which are bad for stocks and bonds alike.
The release just yesterday of the minutes from the Federal Reserve’s meeting on April 26-27 showed that the Fed was concerned that markets were not properly estimating the prospect of a rate hike in June. Fed officials, as was revealed in the minutes, recognize the constructive path of the economy and are actively considering hiking interest rates in June. This was a surprise to investors, who until yesterday considered a June rate hike to be just a 4% probability.
U.S. stocks now trade at 17.6 times expected earnings for 2016, slightly to the high side of the market’s historical valuation range. The financial sector and the energy sector continue to have very weak earnings, however, and a meaningful profits recovery in either sector could put overall corporate earnings back on a growth trajectory. As for the overall economy, it seems likely to stay on its slow-but-steady course as we move into summer.
Please do not hesitate to contact me if there is anything about the markets or your portfolio you would like to discuss.
*Photo credit: www.parade.com