The financial markets traveled to new places in the first quarter only to bring us back and beyond where the journey began. It felt like a year’s worth of turbulence consolidated into three months. Despite the heightened volatility, large capitalization U.S. stocks, bonds and commodities all finished the quarter with positive returns. Let’s look at some key benchmarks.
The double digit stock market declines at the start of the year were caused by a variety of factors. The Federal Reserve raised the Fed funds rate by 25 basis point in December and set market expectations for multiple rate increases throughout 2016. This spooked the markets. Other factors dragging the market down included oil prices declining into the mid-twenties, the dollar strengthening, shrinking corporate earnings, a China slowdown and concerns that a major European bank might collapse.
The turning point came in mid-February as new realities came to light. The Fed’s pace of future interest rate hikes was going to be much slower than initially perceived. Fed chair Janet Yellen successfully talked down the U.S. dollar, turning corporate profit headwind into a tailwind. Oil prices rallied as the path to more balanced supply and demand came into focus. The European Central Bank (ECB) announced plans to embark on a more aggressive bond buyback program boosting European markets. Corporate earnings, while in a period of stagnation, are expected to be very strong in the second half as year over year comparisons will be favorable.
When we tone down the daily market noise and look at the big picture, the markets are reasonably valued. In the bond market, interest rates are low by historical standards; and we expect them to stay low throughout the year. The yield on 10-year U.S. Treasuries are trading in a tight range in a new sub-2% environment. Compare this to interest rates around the world and U.S. bonds look like a bargain. The Federal Reserve will impose just one 25 basis point rate hike this year, likely coming in the second half.
Stock valuations, as measured by price-earnings ratios, are running near their long term average of 15 times. A corporate earnings recovery expected in the third and fourth quarters has the potential to move prices higher into year end. The stock market swam upstream in 2015 as the strong dollar and falling oil prices took a significant bite out of corporate profits. These obstacles are now fading away providing a path to a better earnings picture later this year. Stock market volatility spiked in the beginning of the quarter and subsided as the market rebounded. Don’t be fooled. Volatility will be here for the remainder of the year as economic and political uncertainties will create bumps in the road.
The markets will always test investors’ resolve. If you monitor the markets and your portfolios on a daily basis, the bumpy road is more likely to throw you off course. It is important to remember capital markets do not move up or down in straight lines, but the long-term direction is upward. Keep a long-term market perspective on your financial plan and let the market work for you over time.
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