2016 Q1 Economic Update from Transition Financial Advisors, Inc.
What a welcome to 2016! The stock markets have greeted us with the worst start in history. Although that makes for a great headline, in reality, there is no predictive value to a good start or a bad start. From our perspective, it has been quite some time since the media headlines have been this negative. Of course, the media gets rewarded for sensationalism. Investors get rewarded for patience and a long-term view.
Let’s begin with our economic outlook. Although global growth has been decelerating and downside risks do persist, we believe that the global economic recovery that began in 2009 will continue. The IMF (International Monetary Fund) estimates global GDP growth will increase to 3.4% this year, and while we are hopeful that they are correct, we think the challenges from China and other emerging market economies are significant enough for us to be skeptical of that forecast. But we do believe that 3% global growth is quite manageable.
In the U.S., we don’t see any signs of inflation and with lower oil prices, a strong U.S. dollar and economic weakness overseas, we think the inflation rate will stay low for quite some time. This leads us to believe that the Federal Reserve will be extremely cautious in raising rates in 2016. They may hike again in March, but any further moves will most likely require an improving global economic backdrop.
In many ways, the U.S. is still the brightest spot in the world economy. Consumer spending has remained quite robust and the real estate market is healthy. Growth rates remain low, in the 2% – 2.5% range, but stable. Although recession has been tossed around in the media from time to time, the consensus shows there is very little data to support that view.
We see Europe mostly as a positive and definitely as a continual work-in-progress. The good news is that the European Central Bank’s (ECB) accommodative monetary policy continues to gain some traction. The Euro-Zone economy is recovering, but it’s hard to get too excited when GDP growth is 1.5%. Fortunately, it appears Europe will continue to get monetary stimulus from the ECB. In his speech last Wednesday, Mario Draghi (chair of the ECB) clearly opened the door for further monetary easing in March. European markets rallied nicely on those comments.
Much of the world’s economic woes have been thrown at the doorsteps of China. Certainly, Chinese growth has slowed, but behind the headlines is a bigger economic story: China’s transition away from a manufacturing and investment-based economy to one based on consumption. Despite all the uncertainty we are experiencing today, Chinese consumers have continued to serve as a relatively resilient source of sales and earnings growth for high-quality domestic firms as well as leading multi-nationals. Earlier this year, Beijing announced several policy initiatives designed to stimulate aggregate demand. Although many are skeptical, the jury is out on whether the Chinese government can deliver on their promises.
How have global stock markets performed this year? The MSCI All Country World Index, which measures all major developed and emerging stock markets, fell into bear market territory on Wednesday, the 21st of January. With its decline from early last year totaling more than 20%, we are officially in a global bear market. To review, a stock market correction is defined as a decline of 10% or greater, while a bear market is defined as a decline of 20% or greater. The media has jumped on the “bear market” theme, making it the primary headline everywhere. It is important to note that a bear market is simply a description of a historical event. It is not a prognosis of the future! Many people hear bear market and believe the market is now going to tumble . . . it is simply a description of what has occurred, offering no prediction of the future. Besides, can anyone predict the future?
To give us some perspective on the current market environment, we have provided a table of various countries and their stock market returns as of January 20th.
Country Return Country Return
As you can see, most stock markets are either in correction or bear market territory. At times like this, it is important to remember that while declines have varied in intensity and frequency, they have been somewhat regular events. It’s also important to realize that the market has always recovered from declines. Below is a chart showing the history of declines and average length of time for recovery:
|History of Market Declines
Dow Jones Industrial Average, 1900–2014
|Type of decline||Average frequency1||Average length2||Last occurrence|
|–5% or more||About three times a year||46 days||December 2014|
|–10% or more||About once a year||115 days||October 2011|
|–15% or more||About once every two years||216 days||October 2011|
|–20% or more||About once every 3-1/2 years||338 days||March 2009|
- Assumes 50% recovery of lost value
- Measure market high to market low
Studies show that people place too much emphasis on recent events and disregard long-term realities. Including downturns, the S&P 500’s mean return over all 10-year periods from 1927 to 2014 is 10.54%. Sensational news headlines about markets crashing are meant to grab your attention, so remember to ignore the noise and be patient and stay focused on your long-term goals. As Warren Buffett has said “The market is the most efficient mechanism anywhere in the world for transferring wealth from impatient people to patient people.”
After OPEC created a monopolistic structure in the 1960’s, it was considered good economic news when oil prices would fall. Things have certainly changed since then. The collapse in oil prices, while benefitting consumers, is also creating havoc in a variety of industries and countries. Transportation, valve and tubing suppliers, drilling equipment, well-service, and many other industries are all hurting; Layoffs have been widespread and severe. Countries dependent on oil for domestic revenues (Russia and Saudi Arabia for example) are all making significant cuts in their spending and investment outlays. We now believe that the single most important factor to help stabilize global markets is stability in oil prices. Remember, this is primarily an over-supply issue as more oil has come online through fracking, Iran, etc., not a demand issue. The global demand for oil is projected to increase by 1.2 million barrels a day in 2016 so we are hopeful that supply-demand equilibrium can be reached later this year.
Although weakening global demand has cast a shadow, U.S. company earnings overall appear to be in decent shape. While earnings expectations have plummeted for industrial and energy-related areas, a broad array of consumer-focused companies, like home improvement and internet retailers, are generating strong profits. Although the final data is not in yet, year-over-year corporate earnings for 2015 are expected to decline -0.8% while revenues are expected to decline -3.4%. Earnings estimates for early 2016 are also slightly to the downside, but overall, analysts are still projecting earnings growth of 6.7% and revenue growth of 3.9% for the year. Markets are behaving as if earnings will continue to fall throughout all of 2016. Therefore, if these earnings estimates are correct, or even close to being accurate, the market should not only recover the losses sustained this year, but may go on to reach new highs.
We hope this puts a truer perspective on all the “noise” you are hearing from the media. The world economy is not falling apart. Markets are doing what they so often do. If you need any further reassurance, please contact us.
Transition Financial Advisors Group, Inc.
Mitch Marenus, Chief Investment Officer
MBA, CFP® (US), CFA®
Brian Wruk, President
MBA, CFP® (US), CFP® (Canada), CIM, TEP
Lucas Wennersten, Financial Advisor