Outlook March 31, 2016


At the March Meeting Fed Chair Janet Yellen announced that the FOMC did not increase the Fed Funds rate as was greatly expected. Reasons for holding off on the next rate rise include inflation firming at a decent pace yet below target and employment remaining steady. Chair Yellen also stated recently that “global economic and financial developments continue to pose risks” impact the pace of rate increases. Market participants showed their support for the Fed’s “Dovish” stance on monetary policy by rallying the broad stock market indices at the end of March.

Living in the modern world we are accustomed to buying foreign goods without a second thought. Coffee from South America, shoes from Italy, clothing made in China, India and Bangladesh, food from Europe, electronics from China, and the list goes on. Naturally, the FOMC is aware of the impact that US monetary policy may have on foreign economies and markets. Our Federal Reserve considers the impact on the global economy although it does not have the charge to be the monetary authority for the world.

News from abroad includes the People’s Bank of China committing to support the Renminbi in an effort to prevent a meltdown. In addition, the European Central Bank implemented a “Negative Interest Rate Policy” (NIRP) on bank deposits intending to encourage bank lending on the Continent. The NIRP as a monetary tool had been employed by the Swiss in the 1970’s, and a couple of times in the last six years by Sweden and Denmark. The impact of the NIRP on deposits of this magnitude is yet to be seen. These actions demonstrate that Central Banks are co-operating with the common purpose of maintaining global financial stability.

Leading indicators are remaining strong on a year-over-year basis, but while the news is encouraging, they do not indicate that the economy is growing at a rapid pace. Tepid is more like it. The economy has grown at about 1.3 percent per year on average over the past seven years, including a higher real growth rate of about 4% in 2014 and 2015, and slight declines on a quarter-to-quarter basis. Recent expectations of growth for the domestic GDP are near zero for the first quarter. This “soft patch” is not the same as a recession. Our research indicates that recessions in the US are typically preceded by a spike in commodity prices. Commodity price indicators remain at low levels and are well below the 2008 peaks. Consequently we believe the risk of recession remains low in the next year.

Sentiment Remains Cautious

Market participants find it difficult to look at the investment climate without using 2008 goggles. We hear from our clients that they fear a repeat of 2008. We see many bright spots in the financial landscape supporting the strength of two key segments of the economy: businesses and consumers. Housing starts and permits reported for February 2016 are more than twice levels reported in April 2009. March’s Conference Board Consumer Confidence Index is at 96.2, light years above the March 2009 low of 25.3. Consumers are nearly five times more confident about the future than they were seven years ago. Homes sales are rising, the personal savings rate is strong and the job market is good. Business activity, as indicated by the ISM, shows that the manufacturing is growing – not shrinking as it was in 2008. More than 14 million jobs have been created since the beginning of 2010. The Unemployment Rate in the U.S. hovers near 5% which we believe to be a very healthy level.

The Stock Market

The S&P500 Index dropped 9.5% between December 29, 2015 and January 15, 2016 due to concerns of a global recession. Interestingly the decline paralleled a fifteen percent drop in oil prices. Fears of an economic decline subsided and the market recovered, ending up 1.5% for the first quarter.

Reported corporate profits in 2015’s fourth quarter were weaker than anticipated capping the third quarter in a row of flat to down earnings. The outlook for the first quarter of 2016 is unappetizing as well. Two factors weighing on earnings of late include the strength in the U.S. dollar and the energy sector recession. Oil prices stabilizing recently are expected to stem the flow of red ink from energy companies by the second half of the year. Strategists estimate that S&P500 Index earnings for 2016 will be eight percent above the prior year.

March 9, 2016, marked the seventh anniversary of the beginning of the equity bull market. Stocks rose from very low values during the Great Recession to recent peaks. Easy monetary policies, low interest rates and a growing economy pushed stocks higher. The three legs of the stock market as we view them are earnings, valuation and sentiment. Earnings for companies in the S&P500 Index declined by 4.2% in the fourth quarter of 2015. Earnings were impacted by a 73% decline in energy stocks’ reported earnings and sales pressures as a result of a strong U.S. dollar. First quarter 2016 earnings are expected to rebound 25% from $23.06 fourth quarter 2015 earnings to $29.00.

Market Indicies (Total Return as of 3/31/2016)
YTD% 1-Year% 3-Year%* 5-Year%*
S&P 500 1.3 1.8 11.8 11.5
NASDAQ (2.8) 0.7 15.7 13.3
Russell 2000 (1.9) (9.8) 6.8 7.2
MSCI World ex-USA** (2.9) (7.8) 2.9 2.9
MSCI Emerging Markets** 5.7 (11.7) (4.2) (3.8)
Source: Bloomberg Finance L.P; *Annualized; **USD

Valuation as measured by the forward S&P 500 Index P/E ratio stands at 16.6x next twelve months’ earnings. The 25-year average forward P/E is 15.8x the next twelve months’ earnings. Based upon this comparison current valuations are reasonable, neither cheap nor expensive. As an indication of yields available today the 10-year treasury yields 1.7%. By comparison the S&P500 Index dividend yield is 2.2% and coupled with future growth presents an attractive alternative in those situations where risk can be tolerated for a period of time. Sentiment or investors’ feelings toward the current environment, remains difficult. Typically the Presidential election cycle is neutral with respect to market performance. It is different this time as the primary election process has become a circus of extremes, emotions and diversions from the real issues facing the U.S. today. Regrettably these emotions swamp earnings and valuations as investors determine the best places in which to invest.

Our investment philosophy begins with an analysis of our clients’ needs for growth and income. Once an Investment Objective has been determined a custom investment program is implemented and managed for our clients. A low return environment provides the back drop for our analysis and underlies our expectations for the near term. Our Wealth Management specialists are available to discuss aligning your investment program to reach your financial goals.

Rich Gartelmann CFP® – (630) 844-5730 rgartelmann@oldsecond.com
Jean Van Keppel CFA® – (630) 906-5489 jvankeppel@oldsecond.com
Brad Johnson CFA®, CFP® – (630) 906-5545 bjohnson@oldsecond.com
Joel Binder, SVP – (630) 844-6767 jbinder@oldsecond.com
Jacqueline Runnberg CFP® – (630) 966-2462 jrunnberg@oldsecond.com
Ed Gorenz, VP – (630) 906-5467 ejgorenz@oldsecond.com
Visit Old Second Wealth Management

Non-deposit investment products are not insured by the FDIC; not a deposit of, or guaranteed by, the bank; may lose value.

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