Market Strategy Radar Screen Weekly - April 4, 2016

A Tale of Two Markets
One driven by negative projections, the other by improving economic data

All told, stocks were in a downward trend from the last day in 2015 through February 11, 2016 as the market fell 10.51%, weighed down by: concerns over economic growth (including a misperception by many investors that we were headed into if not already in recession), further weakening in international currencies against a strong dollar and plunging commodities’ prices, led by oil, which took investor focus and opinion hostage.

Then things suddenly appeared to change. Or was it just a change of perception and projection?

From the low established on Feb. 11^th through the last day of trading in the first quarter, the S&P 500 rallied 12.61%, ending the quarter just 0.77% above where it started the year, effectively having made just a little bit better than a  round trip from where it ended the fourth quarter of 2015.

Improving stateside economic data along with actions taken (and not taken) by central bankers in places as distant as the US, Europe, the UK, Japan and China turned the beat around, and the market changed direction to march to the beat of a different drummer.

Change in Currency Value versus US Dollar in Year to Date through April 1, 2016

G-10 Currencies:

Emerging Market Nation Currencies:

Source:  Bloomberg, OAM Research.

Last Friday, the first day of April, the market advanced a little over three-quarters of a percent on the day, closing at 2072.78, or 1.41% above where it had started the year and just 2.7% below its record high of 2,130.82 set last May. 

Among the factors that caused the market to change direction and move higher we’d include:

• A rotation stateside out of growth and into value (see figure at right);
• A broad weakening of the dollar as the greenback lost ground against nine out of ten G-10 currencies and against 20 (of 24) EMs currencies by the end of the first quarter (see figures at left).
• Apparent near-term stabilization in the price of oil;
• Rallies in a broad array of commodity prices;
• Further actions taken by foreign central bankers to counter deflation in Europe and Japan as well as efforts taken by  officials in China to counter sluggish growth;
• Improved economic data stateside centered on job growth, consumer confidence, housing, auto sales and even some improvement in manufacturing (as the quarter neared a close), as well as the effect of a moderating dollar that proffers support of US businesses, particularly those with operations abroad, including US multinationals;
• Comments from Fed Chair Janet Yellen indicating that the Fed will remain sensitive to economic weakness abroad even as it remains committed to a process of interest rate normalization in the US.

From the equity market’s low point on February 11^th, stocks rallied globally, led by the US, with the S&P 500, the S&P 400 (mid-caps) and the Russell 2000 (small-caps) respectively moving 12.61%, 16.66% and 16.81% higher.

Foreign markets as represented by the MSCI EAFE (developed markets ex-US and Canada), the MSCI Emerging Markets index and the MSCI Frontier markets index rallied 10.48%, 17.36% and 3.11% respectively.

Russell Growth and Value Indexes YTD

Source:  Russell Associates, Bloomberg and OAM Research. Change in index values from 12/31/2015 to 4/1/2016

With US benchmark Treasury interest rates now lower than they were at the start of the year, when many investors were looking for the Fed to be more aggressive than it appears it now will be near term and perhaps for the rest of this year, stocks could garner further favor from investors and move higher.

Consider that 2-year, the 5-year, the 10-year and the 30-year Treasury yields are down from their respective highs at the start of the year with (as we go to press):

• the 2-year yielding  around 0.72%, down from 1.05% at the end of last year;
• the 5-year yielding  around 1.22%, down from 1.76% at the end of last year;
• the 10-year yielding around 1.77%, down from 2.27% at the end of last year;
• the 30-year yielding around 2.6%, down from 3.02% at the end of last year

The next hurdle on the wall of worry for stocks is likely valuation as Q1 earnings season comes up on the horizon.

Q1 earnings season will unofficially start when Alcoa (AA) reports results a week from today after the market close on April 11^th.

As of last Friday, April 1^st, the 12-month trailing P/E multiple of the S&P 500 stood at 18.83x, up from a 2016 low of 16.54x on February 11^th of this year (see figure below).

S&P 500 Index Trailing P/E Since 2014

Source:  Bloomberg, OAM Research.

The average 12-month trailing multiple of the S&P 500 all the way back to the end of 1965 stands at about 16.56x. 

At 18.83x, Friday’s trailing 12-month P/E multiple stood at around a 13.7% premium to the market’s long-term average trailing 12- month multiple of 16.54x, and the market (as illustrated by the performance of the S&P 500) has shown resistance to pushing through a level of 19x since February of 2014 (again see figure at left).

That said, the average yield on the 10-year Treasury note since the end of 1965 through last Friday stands at 6.54% versus a current yield on the 10-year of around 1.77%

While economic, revenue and earnings growth are principal factors that move stocks higher, the relative value of asset classes and their respective prospects for better returns can serve as near-term factors determining which asset classes are favored by investors.

Stay tuned. 

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