foreign based earnings
Stocks, measured by the S&P 500, generated a total return of 3.8% for the first six months of 2016. By most accounts, this is a below average year for stocks, and the sub-par returns in hand have been hard fought. From the get go stock prices fell, and (cumulatively) did not turn positive until March 17th. The S&P 500 inched its way higher (toward its 2,130 all-time high set in May 2015) until the Brexit vote surprisingly knocked 5.4% off prices in two painful days.
Stock price declines (5% two-day declines) are not uncommon, except when the market is trading within 1% of an all-time high. As noted by Bespoke Research, before the Brexit vote the S&P 500 was 1.6 standard deviations above its 50-day moving average and two days later it was 3.2 standard deviations below. The two day swing was the steepest on record over a period spanning close to 90 years. Much of this was “noise” thanks to computer driven trading in ETF’s and futures.
Investors were clearly caught off guard by the Brexit vote and then sucked into a vortex of misinformed commentary. As much as Brexit captivated the world’s attention and whip-sawed stock prices, I think it will prove to be both a local issue and a political bone in the craw of an older generation. I would expect longer term it will hamper an already sluggish UK economy and spur another Scottish secession vote. Near term the implosion in the value of the pound will be a tailwind.
In my opinion, we are better served focusing on some of the more obvious risks to both the global and US economies. One critical factor is China. As we saw last August, concerns over slowing economic growth, and the steady devaluation of the Chinese currency (the RMB), are true global risks as China is the largest contributor to global GDP growth. I suspect these concerns have not been put to rest.
The outlook for S&P 500 earnings for the second half of 2016 is favorable, largely due to low interest rates, a tempering US$, and higher oil prices. The US 10-year is yielding around 1.4% and due to macro factors, rates may well surprise and trend lower as global capital seeks safe haven. The US$ has stabilized (stopped rising) which will provide a huge tailwind to US companies repatriating foreign based earnings. And, oil prices, the culprit for much of the turmoil markets have suffered over the last 18 months, have stabilized. A good sign is inventories appear to be on the decline. Supply and demand will come together. With oil prices in the $50 bbl range, volumes of economic activity will come back on line, and with it, $’s of lost earnings.
Overall, the undercurrents of the market have not changed since the start of the year. For the time being, large cap value is outperforming growth, and small and mid cap stocks are generating stronger returns than large cap stocks. Dividends (REITs, utilities and most consumer staple stocks) have been the big attraction for investors this year. They have become expensive. While I expect the interest in dividend yield to continue, I think the growth stocks will come back into fashion when the S&P 500 begins to show evidence it is breaking out of its long running earnings slump.
Though confusion reigns from time to time, I think we can take heart in a brighter long term outlook. The millennials (born 1981-1997) are now the largest generation, at roughly 75 million, and are the largest share of the American workforce (Pew Research Center). The millennials are just starting to get married, buy homes and have children. The US is on the verge of a tremendous demographic dividend as the largest share of the population for the coming years will be young, highly educated, and ready to consume (Bespoke Research).
Over the years, common sense and an attentive hand have allowed us to navigate some challenging markets. Our approach is to anchor on facts, take a long term view of what we’re all about, and to acknowledge (and refine) an effective process. We are here to serve you. In these curious times, if you would like to share your thoughts or schedule a review, we would love to hear from you.
Bruce Hotaling, CFA