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Focus on fundamentals to face volatility

Earnings and interest rates drive stocks in the long run, Steve Giles says, and they should remain the focus of investors, especially when markets are volatile, as they have been to begin 2016. Steve spoke with Joel Dresang in a Money Talk Video. A transcript of their discussion follows.

Joel Dresang: Steve, the stock market has fluctuated a lot to begin 2016. We had a correction; by the end of the first quarter, the market was back up again. At the same time, we’ve had consistent measures of economic growth. How should investors take those mixed signals?

Steve Giles: Well you know, Joel, I think the first quarter is a great reminder for investors to stay balanced and focused on the long term, which is the fundamentals.

Joel: And the fundamentals, you’re talking about earnings and interest rates.

Steve: That’s absolutely right, Joel. Earnings and interest rates are what move the markets longer term. Everything else is just peripheral noise.

Joel: Okay, let’s talk about interest rates. The Fed is gradually raising short-term rates?

Steve: I think raising rates is important because it does help the Fed return to a more neutral monetary policy. But right now rates are very, very low. They’re at historic lows, and what that does right now for the markets is it encourages investors to look for other opportunities elsewhere. In a very low interest rate environment, you might find better dividend yields in the stock market.

Joel: And what do we know about the pace that the Fed is going to use for raising those rates?

Steve: The Fed has promised to slowly ease back into a more neutral monetary policy. It means they’re going to be raising rates very slowly over the course of the next couple of years. And during that time, in a traditionally low, historically low, interest rate environment, that’s going to create a bit of a tail wind for the stocks.

Joel: And what about earnings? When the market was down, we heard a lot of complaints about the strong dollar and weak oil prices.

Steve: It’s impossible for the market not to react when you go through a period like we had in 2015. Let’s face it, oil prices were down, and that had a very negative impact on earnings across the board. So when we look at what happened in January and February, it’s safe to say that the market was responding to those negative earnings.

We have had a lot of head winds in the first quarter that have now become tail winds.

You saw a very low price in oil. We hit the mid-20s. That’s now recovered. We also had a very strong dollar, which has weakened. And it seems counter-intuitive that a weaker dollar helps the economy, but keep in mind that when you have a dollar weaken, you’re creating better export opportunities for our companies. And those better export opportunities are going to create better profits longer term.

Joel: So earnings and interest rates. What about valuations, what are stock prices telling us right now?

Steve: We’re seven years into this recovery, Joel, and you would think that the market might get to a point where we’re overvalued. But when you look at P/E ratios, we’re just a tad above average.

Unlike what we saw back in the tech rally days in early 2000 with P/E ratios in the mid-40s, you’ve got a P/E ratio coming in right around 16, which is just above the historical average.

And that, to me, says the market is fairly valued. I think what you want to avoid longer term is overpaying for what you buy. We always try to focus on getting a good deal for our clients and getting a good deal for what we buy longer term. And if the market’s trading right now at average, I think longer term, that bodes well.

Joel: So bottom line, what should long-term investors do with all of this fluctuation in the stock market?

Steve: I think it’s important for investors to stay balanced. Bottom line, have a portfolio that’s going to be able to withstand any kind of market environment, such as we saw in the first quarter. Focus on the long term, focus on earnings, focus on interest rates and pay attention to that balance.

Steve Giles is vice president and investment advisor at Landaas & Company.
Joel Dresang is vice president-communications at Landaas & Company.
Money Talk Video by Jason Scuglik and Peter May

Learn more

Volatility: What investors should know, a Money Talk Video by Marc Amateis
Avoid rearview mirror investing, a Money Talk Video by Steve Giles
The importance of balance for investors, a Money Talk Video

(initially posted April 22, 2016)

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