The stock market started the new year by stumbling out of the gate and falling flat on its face. The Dow Jones Industrial Average dropped 6.2% in the first week of trading – its worst start to a year ever. By the close on February 11, the venerable index had dropped over 10% for the year and almost 15% from the all-time high established in May of last year.
A rally thereupon ensued that carried the Dow to a closing level on March 31 that represented a price gain of 1.5% for the quarter. While that return might be nothing to write home about, the market’s wild ride was headline news as over half of the trading days during the period witnessed intraday moves of 1% or more. Can you spell v-o-l-a-t-i-l-i-t-y?
Despite being scorned by many a pundit looking for higher interest rates in 2016, Treasury bonds rallied yet again as yields on long-term government debt fell during the first quarter. A widely anticipated second increase in the federal funds rate by the FOMC never occurred. More on that subject anon.
Commodities were again the biggest losers during the period as the Commodity Research Bureau Index dropped 3.3 percent. There were, however, a few exceptions. After being down over 30% in February crude oil managed to rally in the second half of the quarter to pull even for the year. Gold, moreover, was the biggest winner as, contrary to industrial metals, it jumped 15% due in large part to a flight to safety on the part of foreign investors.
In keeping with recent trends, economic growth remained relatively lackluster although the U.S. economy looks pretty healthy in comparison to many others around the world. Fourth quarter real GDP registered a meager 1.4% gain as the manufacturing sector exhibited weakness late in the year. In January, however, industrial production jumped 0.9% before falling back 0.5% in February.
New orders for durable goods tend to be highly volatile on a month-to-month basis and that has held true of late; yet the trend has been noticeably to the downside. Retail sales proved to be disappointing as well with declines in both January and February. Housing activity, meanwhile, has been relatively flat in recent months.
The brightest star in the economic firmament continues to be the jobs market. After a brief jump in unemployment claims late last year, that measure moved back down early in 2016 to levels implying moderately strong growth in payrolls. Cue the payroll reports which indeed saw appreciable gains in all three months.
Inflation remains remarkably muted as the latest year-over-year changes for the PPI and CPI were 0.0% and 1.0%, respectively. While still below the Fed’s target rate of 2%, they are now much closer to said target than the negative readings that prevailed throughout much of last year.
Over the years, Fed watching has become something of a major industry as analysts and scribes parse every pronouncement by Fed officials, governors and regional bank presidents in hope of discovering clues to the never ending question, “How now, interest rates?” A number of the regional bank spokespersons have lately been opining that the employment statistics, among others, appear to be sufficiently strong to justify getting ahead of the inflation curve by allowing the funds rate to move higher. However, as Lee Corso might say, “Not so fast, my young friends,” as he forsakes the hawks’ mascot’s head and dons that of the doves.
Fed Chairman Janet Yellen has recently put something of a kibosh on the plans for higher rates, at least for the time being. Citing a host of troubling deflationary tendencies in the global economy, Ms. Yellen made it clear that Fed policy will likely remain steady as she goes until more data with stronger growth implications become available.
Why the foot dragging? We noted above that gold rallied sharply in the first quarter in response to a flight to safety. This was not the only indication that fear of loss is now, on the margin, edging out fear of losing out in a rally.
Risk assets other than large cap stocks are giving signals of renewed reluctance by investors and speculators alike to assume risk. We have already mentioned the ongoing bear market in most commodity markets. Furthermore, commodity prices have a long history as leading indicators for the general economy and other risk assets as well.
One of the biggest beneficiaries of the bull market that started seven years ago has been the market for art. Alas, Christie’s and Sotheby’s spring sales this year were down 35% and 50%, respectively. Other collectibles have taken a hit as well. Sales at the Scottsdale classic car auction were down 15% - the first decline since 2010.
In Japan and much of Europe there is over $7 trillion in sovereign debt that is trading at negative yields. In other words, investors are so worried about risk that they are willing to pay the government to keep their money safe for them.
Bull markets, of course, are known to climb walls of worry, so there has been plenty of fuel to drive stock prices higher since mid-February. A closer look at the numbers, however, reveals that the market’s gains have been Pyrrhic in character as the higher the large cap indices have gone, the fewer the number of stocks that are participants.
What does it say when a defensive group like the Dow Utilities is making new highs for the cycle while a more aggressive group like the financial stocks is underperforming? (See charts below.) Large cap indices like the Dow are within shouting distance of the all-time highs established last May. If this is a bull market, new highs should be in the offing. If, however, it is only a bear market rally, a move below the 15,500 support level on the Dow would be expected. There is much at stake here and Chairman Yellen has chosen wisely to keep the powder dry at this juncture.
Weaver C. Barksdale, CFA