Market Perspective for January 22, 2016

Equity markets closed out the week with a strong rally. The rebounds in some markets have been quite sizable as oil rebounded approximately 15 percent from its lows. The S&P 500 is set to rally as much as 5 percent from Wednesday lows. Most earnings are exceeding expectations and extreme negative sentiment looks to have peaked on Wednesday, at least for the short-term.

Many markets started the week “oversold”, with technical traders looking for a reversal. By Wednesday, some investors were in panic mode as they piled into government bonds, but this move peaked at lunchtime. Since then, the market has been in rebound mode and it’s been getting help from the European Central Bank. On Thursday, ECB President Mario Draghi hinted at the central bank’s intent to do more at the March meeting. The ECB is seeking higher inflation, but tumbling commodity prices and falling asset prices are likely to put a damper on inflation in Europe. Adding more liquidity could boost prices at the expense of a weaker euro, and it was successful as a strategy in 2015. European equities did well for most of last year after quantitative easing was started in January 2015. Investors who hedged currency fared even better.

U.S. inflation is comparatively high. Although headline inflation fell in December and is only up 0.7 percent in the past year, a big chunk of which was comprised of falling energy prices. Shelter, which is about one-third of the CPI, is rising at a 3.2 percent annualized pace. Medical services are also rising at a healthy clip of 2.9 percent. Core inflation, which strips out food and energy, was up 2.1 percent in 2015. Given the current state of the commodity markets and the drop in financial assets, inflation is the farthest thing from investors’ minds, but the data suggests things could change very quickly after prices bottom.

Existing home sales jumped sharply in December, up 14.7 percent. Numbers had been down in November and some analysts speculated new mortgage rules were the culprit. The spike in sales indicates they were right. Home prices tend to follow sales volume and this increase is good news for the economy, but it could also put further upward pressure on core inflation.

This was the first full week of earnings season and there were several big reports. Bank of America (BAC) beat earnings estimates for the quarter and saw earnings rise more than 250 percent in 2015, primarily due to the end of litigation expenses, which has fueled rising bank earnings across the sector. Netflix (NFLX) followed with a large earnings beat, reporting 7 cents versus the expected 2 cents. Revenue was slightly below estimates, but overall revenue increased 22 percent versus the year-ago quarter. Shares of Netflix headed lower though, due to slowing subscriber growth in the U.S. and the higher cost associated with adding subscribers overseas. In contrast to Netflix, Verizon (VZ) saw strong customer growth in its wireless division, helping it to beat earnings and send shares higher on the week.

Starbucks (SBUX) beat earnings by a penny, but investors were concerned by slower-than-expected growth in China, plus contraction in Europe.  UnitedHealth Group (UNH) beat earnings estimates, but earnings were down in part due to costs associated with the Affordable Care act. The firm doesn’t have many customers under the ACA, only about 500,000, but it may quit the program after this year due to high costs.

One of the reasons why the market fell into Wednesday was guidance from International Business Machines (IBM). After the bell on Tuesday, the company said it expected to earn $13.50 per share in 2016, below the average forecast of $15.00 per share. The firm blamed the strong dollar in part, but the firm’s shift away from low-margin hardware to high-margin software services is also taking time to pay off.

The week ended with industrial giant and Dow component General Electric (GE) beating estimates by 6 percent, though industrial earnings were down due to low oil prices. Of GE’s eight industrial divisions, five reported a decline in profit. Similar to the earnings growth for the S&P 500 Index, which will likely be down in the fourth quarter due to falling energy profits, GE’s oil and gas division reported a 16 percent drop in earnings pulling the entire industrial division’s earnings growth to negative 1 percent. The firm also missed on revenue estimates as a result.

A market drop can provide a good gut check for investors. If the recent turmoil created a lot of stress or sleepless nights, your risk tolerance is probably lower than you believed. Too many investors overreact to this situation in the short-term, taking drastic steps to reduce pain immediately while ignoring the long-term costs. The best first step is reviewing your portfolio holdings for anything that may be generating a large amount of risk and to reassess your allocation between stocks and bonds. A return to normal volatility may be jarring to investors since we haven’t seen much market action since the 1990s, but a well-planned response will protect and grow your investments in a new long-term, higher-rate environment.

Few can predict the bottom in the stock market, but the CRB Index of commodity prices is already back at levels seen in the early 1970s. China is a question mark due to their economic and currency issues, but the Hang Seng Index in Hong Kong is already trading below book value for the first time since 1998, when the Asian Crisis was in full bloom. It’s impossible to say if a bottom is in or not, but many assets are historically cheap. A well-diversified portfolio and sensible investment plan are key components in keeping your mind free of worry and focused on the growing list of long-term opportunities. If you would like a complimentary review of your investment portfolio, please contact me directly at (844) 336-9878.

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