Keep Your Chin Up and Eyes Open

By Brian Dolan, Head Market Strategist In my 2016 Global Market Outlook, I suggested investors need to look past the short-term market turbulence and stay focused on the big picture. (The Global Market Outlook is also available as a webinar or a podcast.) In that big picture, global growth is expected to pick up relative to 2015 (+3.5% in 2016 vs. 3.1% in 2015); interest rates are expected to remain exceptionally low; and inflation is nowhere to be seen. In normal circumstances, that would be considered a ‘Goldilocks’ environment: not too hot; not too cold; just right.

Focus on the Big Picture

And yet world markets continue to spasm. In my global outlook, I dismissed the volatility in Chinese markets as the result of a further unwinding of the retail investor-driven bubble that burst in summer 2015, aggravated by official missteps in the market.  More importantly, I highlighted the absolute lack of any meaningful historical relationship between Chinese stock markets and other major global indexes:

Chinese Stock Market

(A correlation near-zero indicates no statistical relationship between the two indexes, meaning movements in one index have little to no meaning for movements in the other.)

Looking past China, again, we’re left with modest, yet stable growth outlooks in major developed economies. I look for additional moves toward lower interest rates from the European Central Bank (ECB) and the Bank of Japan (BOJ) in the coming months, which should support economic and market outlooks there. I also look for the US Fed to eventually signal a lower rate hike path, more in line with current market pricing of only two rate hikes this year.

Emerging markets (EM) remain beleaguered for the time being, to be sure, but the big picture drivers of EM weakness, US dollar (USD) strength and commodity weakness, have largely run their course in my view.  However, it will also likely take several more months at the minimum for EM to stabilize. I expect dissipating US Fed rate hike expectations over the course of the year to also limit USD upside and support EM stabilization.

Look Beyond 4Q Earnings Season

Turning to US markets in particular, 2015 4Q earnings season is upon us. Before being overcome by negative earnings talk, it’s important for investors to understand the sources of a likely weak earnings environment. First and foremost, the biggest drags on earnings have come from USD strength and oil weakness. The trend higher in the USD looks to have peaked in Nov/Dec of 2015 (seen in the US Dollar index chart below), though the greenback has yet to see any significant pullback. In the months ahead, I look for the USD to soften as Fed rate hike expectations are factored out of markets.

US Dollar Index

Source: Bloomberg; DriveWealth

Oil prices have made new lows just this past week, and while there is no sign of an imminent rebound, momentum studies suggest the most recent slide is excessive and potentially divergent (new price lows are not being confirmed by momentum studies). On a contrarian basis, so-called ‘experts’ are now coming out of the woodwork warning about downside oil risks. Really?

On a sector basis, the sharp weakness in oil prices is expected to deliver a huge hit to energy sector earnings (no surprise there; already priced in). Oil and gas earnings are expected to register a 73% decline in the 4Q. Beyond the energy sector, however, the bad news is not so bad. Excluding the energy sector, profits for S&P 500 companies are only expected to fall by 1.6%. Not quite the ‘sky-is-falling, earnings recession’ scenario we’re likely to hear about in coming weeks.

Investing Strategies

Staying with a long-term view, and potentially taking advantage of a short-term rebound, I remain most heavily concentrated on stocks. My view is underpinned by expectations of a low interest rate environment for years to come, leaving few alternatives to equities to generate meaningful returns. My own preference is to focus on developed market stock indexes, but also to begin to add/build a longer-term EM stock index exposure.

Apart from not panicking and riding out the current storm, what else can investors do to take advantage of the opportunities markets have presented us? Here are a few ideas:

  • Asset re-allocation: Investors holding bond investments could consider shifting those assets into stocks. With interest rates having dropped to begin 2016, bond funds will have seen price gains. An allocation shift could lock in those profits and re-deploy to stocks to take advantage of price declines.
  • Invest free cash: Depending on your circumstances, you may be expecting a year-end bonus or possibly a tax refund, or both. Now is the time to make deliberate plans about what you’ll do with that money, while your head is clear and the money is not burning a hole in your pocket. If you’ve always wanted to start investing, but never quite got around to it, now might be the time to invest a portion of that free cash.
  • Stick with your investing plan: If you’re investing through a regular payroll deposit plan, such as a 401k, SEP or other employment-based savings plan, stick with it. If possible increase your contributions if you can afford it and are allowed to. Your recent contributions are being invested at lower costs, reducing the overall cost basis of your investments.

Above all, remember that the market is not the economy. The old saying is that ‘the market has correctly predicted 9 of the last 4 recessions.’  Stay focused on the big picture and your long-term investing goals.