The first quarter of 2016 was anything but boring. Fears of potential recession caused U.S. stocks to fall more than 10% in just the first 10 days of the new year. By quarter- end, U.S. stocks bounced back into positive territory as the S&P 500® Index illustrated in the graph below, but we contend that this rebound is anything but stable.
To explain the drastic fall, three factors were largely pointed to by analysts: China, oil prices, and potential interest rate hikes.
Let's start with China. Stocks there plummeted 23% in January responding to slowing bank and corporate bond issuances.1 The Bank of China then pumped 870 billion yuan into the market to provide at least temporary liquidity and stability in capital flows, but the looming concern of the country’s currency devaluation still very much exists. In fact many experts, including legendary investor George Soros, believe that China’s market is due for a huge correction as it moves its currency to a free-floating, market-based system over the next two years.2
Another major contributor to the first quarter market nose-dive was the drop in oil prices to under $30 a barrel. As of late April the price of a barrel of oil is back up to the mid- forties but as noted in The Fiscal Times recently, the market remains oversupplied while production continues to outpace demand.3
Lastly, the prospect of another interest rate hike may have played a role in the first quarter’s market hiccup. However, in light of China’s volatile market and weak oil prices globally, the Federal Reserve has delayed any such actions until further notice.
As if these three pending market risks don’t still pose enough of a threat to equity investors, the issue of inflated stock prices is well-described in Reuters’ April 23rd article, “Upside Limited for 2016 Even as Earnings Bottom”. Specifically, the S&P's forward price-to-earnings ratio stands at 17.8, the highest since 2004 and sharply above the average 15 level over the past 30 years.
All of this is without even getting into the political drama of our presidential race. Indeed, from our perspective, we are certainly not out of the woods yet.
1. CNN Money: Wild January Stock Market Ends on a High Note. By Matt Egan, January 31, 2016.
2. Market Watch: Is George Soros Right About the Coming Crash in China? By Craig Stephen, April 22, 2016
3. The Fiscal Times: Speculators are Driving Oil Prices Higher. Can That Last? By Anthony Mirhaydari, April 22, 2016
The views expressed in this commentary do not necessarily reflect the views of Cambridge Investment Research, Inc.. This commentary does not constitute an offer to sell any securities or the solicitation of an offer to purchase any securities. There is no assurance that the investment process will consistently lead to successful investing.