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Searching for inflection


By Kyle Tetting

There’s no shortage of vocabulary to describe market volatility. Stocks bounce and markets plummet, interest rates soar and, in tough times, portfolios sag. In mid-February, with U.S. stocks retesting lows from last August, many investors wondered what it would take to shake the recent trend.

Yet, just three days removed from those lows, markets had recovered nearly half of their 2016 losses.

Global growth concerns had not been resolved and questions about the oil market remained, yet stock declines were once again rebuffed at key levels. Cyclical stocks, dependent on the ups and downs of the overall economy, led the charge higher in a sign that optimism remains for the U.S. economy. Such confidence is well-founded in light of most measures of economic progress.

The employment picture has continued to strengthen. The unemployment rate in January fell below 5% for the first time since the start of the Great Recession, and employers remain reluctant to let go of employees. Wage growth remains stagnant, but there are signs that more workers are comfortable quitting in search of new work, a key component in stimulating wage pressures.

Consumers, accounting for nearly 70% of U.S. GDP, are well-situated. Household debt has settled at its lowest level in more than 30 years, and net worth has increased nearly 30% above pre-recession highs. Individuals have translated savings at the gas pump into a more stable household budget while still spending on new cars, vacations and movies. Despite increased spending in a few areas, we have yet to see the full impact of lower energy prices, suggesting that recent gains remain sustainable.

Earnings estimates for 2016 reflect a commodities market that has further deteriorated, delaying any earnings recovery in energy and material stocks. But, even if commodities prices remain low, energy and materials stocks should show year-over-year earnings growth in the second half of the year. Such growth will put an end to the headwinds that have held back the earnings of the broader market. Importantly, at current prices, the S&P 500 earnings multiples suggest stocks are reasonably priced.

While stocks and the economy can remain at odds for an extended period, recessions have accompanied eight of the last 10 bear markets. Aside from broad market pessimism, it is more important to consider signs of continued economic expansion. Economists are calling for GDP growth around 2.5% in 2016. They see just a one-in-five chance of a recession in the next 12 months. It appears unlikely that recessionary pressures will lead to further market declines.

In the absence of the typical characteristics of a bear market, investors are left to wonder what will ultimately turn the tide as stocks remain subdued. The economy continues its slow progression, headwinds are dissipating and earnings growth is sure to follow. Some experts even suspect that oil prices already have bottomed and the value of the dollar peaked.

Such news has yet to sustain a recovery in stocks, but investors waiting for an inflection point just might be overlooking all the small things that have supported the market through all the recent uncertainty.

Kyle Tetting is research director and an investment advisor at Landaas & Company.

(initially posted Feb. 25, 2016)

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