Markets warming after cold start
In a welcome sign of spring, the stock market has thawed from its icy beginning to 2016. U.S. stocks rallied from their February low as the S&P 500 posted gains for five consecutive weeks, overcoming a 10.5% decline to start the year.
The persistent head winds of low commodity prices, a strong dollar, weak global growth and fears of interest rate hikes have quietly shifted to tail winds, supporting the market’s rejuvenation. The S&P 500 closed March up 1.3% for the year so far, including dividends.
Oil has risen past $40 a barrel at times, reigniting optimism in the energy sector. The sector’s earnings are closely tied to the price of oil, with growth largely dependent on stable or rising prices. While oil prices remain below year-ago levels, steep declines in the second half of 2015 have lowered the hurdle for energy companies in the second half of this year.
Importantly, much of the recent market shift coincides with a meaningful drop in the U.S. dollar. Compared to a basket of foreign currencies, the dollar had strengthened more than 25% in the three years ended Jan. 31. Since then, the dollar has weakened 3%.
While it sounds patriotic to favor a stronger dollar, the dollar’s strength can place U.S. corporations on an uneven playing field in foreign markets, either raising the price of their goods in non-dollar currencies or lowering the value of their sales made outside the U.S.
For instance, Apple Inc. Chief Executive Tim Cook explained in the company’s fourth-quarter earnings call that compared to the same period the year before, every $1 of Apple’s sales outside the U.S. lost 15 cents when translated into dollars. With nearly 50% of S&P 500 revenue coming from outside the U.S., even a slight weakening of the dollar has investors cheering U.S. stocks.
Further weakening is unlikely while the rest of the world continues to grapple with slow or decelerating growth. China, Japan and the European Union continue to attempt to stimulate economic growth, but progress has been slow. Negative interest rates and the impact of economic stimulus take time to be digested by such massive economies.
Back in the U.S., fears of quickly rising interest rates have been allayed by Federal Reserve Chair Janet Yellen, who has advocated a slower path for increases. The core Personal Consumption Expenditures index, the Fed’s preferred measure of inflation, increased just 1.7% over the previous year in February – still below the Fed’s 2% target.
In the absence of excess inflation, Yellen and the Fed can continue with more accommodative policies to help mitigate the impact of slow global growth. The dollar’s recent weakening reflects these shifting expectations for interest rates here in the U.S.
As encouraging as the recent market thaw might be, uncertainties remain. The occasional April snowstorm reminds us to remain on guard. Approaching each day with a balanced plan for the long-term prepares us for whatever comes along.
Kyle Tetting is research director and an investment advisor at Landaas & Company.
(initially posted March 31, 2016)
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