First Quarter 2016 Review & Outlook

“The market is the most efficient mechanism anywhere in the world for transferring wealth from impatient people to patient people.” – Warren Buffett

Most roller coasters follow a common pattern by initially traveling up a steep hill and then declining rapidly. The fear usually begins in earnest on the initial precipitous decline. In contrast, the stock market did the exact opposite during the first quarter of 2016. The year began with a steep and fear-inducing decline that sent the Dow Jones Industrial Average to its worst ever 10- day start since the index inception in 1897.

Plunging energy prices and fears about China’s declining growth rate were major contributors to the market’s steady descent in January and early February. The decline in the Dow Jones Industrial Average reached over 10 percent for the year by mid-February. The stock market “roller coaster” then began a steady climb to end the first quarter in positive territory.

Declining energy and commodity prices were the major market stories of 2015. The decline and subsequent recovery in energy prices in the first quarter of 2016 was remarkable in both its speed and classic V-shaped recovery. The price of oil went from $37.04 per barrel on the last day of 2015 to $38.34 at the end of the first quarter. That relatively small move masked the fact that oil was up a whopping 46% from the low it had set just over a month and a half earlier in February. Clearly energy prices played an out-sized role in the extreme market volatility experienced in early 2016.

The investment environment has also been distracted by the contentious and headline grabbing US Presidential Primary season. It seems this year there is a higher than normal level of big issues, big personalities and riveting drama. The non-stop news coverage of the heated political rhetoric should continue to affect investor psychology until the last election returns are tallied in November.

In December 2015, the Federal Reserve raised the target range of the federal-funds rate by 25 basis points to a still historically low range of 0.25% to 0.50%. This was the first increase in rates since 2008. We entered 2016 expecting interest rates to rise further, even though the pace was expected to be slow and deliberate. However, the path to rate normalization has since been put on hold until further review given concerns of slowing world growth. Despite the December rate hike, the ten-year Treasury note yield actually declined from 2.27% at the end of the year to 1.79% as of March 31st. Expectations have now been lowered for the Fed to only raise rates once or at most twice over the balance of 2016. We maintain the opinion that it will be difficult for the Federal Reserve to move rates higher by any significant measure given the propensity of other central banks continuing and/or expanding stimulative monetary policy.

Most economists now expect the United States economy to grow approximately 2.1% in 2016, which would continue our trend of tepid growth. A positive note was that consumers modestly increased their spending in the fourth quarter of 2015 and early in 2016, as they benefited from lower oil prices at the pump. Corporate earnings have faced significant headwinds over the past year from slowing world growth, the strong dollar, and falling commodity prices. As the negative impact of these trends subside, we see opportunity for modest earnings growth going forward.

As of the end of the first quarter, the stock market appears to be fairly valued on a price to earnings (P/E) ratio basis. The S&P 500 was trading at 18.2 times the past 12 months of earnings, which is higher than its 10-year historical average of 15.8. However, the premium over the historical valuation measure seems justifiable given the continued low level of interest rates. We see the future direction of the market contingent upon resumed earnings growth due to the abatement of the negative trends of the past year.

We continue to position portfolios in light of our economic outlook. With the expectation of low interest rates going forward, we believe investors will continue to be attracted to dividend oriented equity investments. For clients with individual stock holdings, we continue to focus on purchasing high quality companies with strong balance sheets.


Marietta Wealth Management, LLC