The first quarter of 2015 is, thus far, looking a lot like ‘14. Similar to ’14, the S&P 500 Index was down 3.1% in January, up 5.5% in February, and then down 1.7% in March, leaving the index up just 0.5% for the first quarter of 2015. Our 2015 market, similar to 2014, is waiting with great anticipation to see what the Federal Reserve Board has in store.
Wall Street loves that the Federal Reserve has been patient in raising interest rates. Shortly after the financial crisis, the Fed put in place near-zero interest rates and hasn’t touched them since. These low rates were the driving force behind the roughly 200% rise in stocks since early March 2009, but the low rate party is about to come to an end. The question asked in the first quarter was: when? That answer is still not a certainty.
Following two straight years of positive quarterly returns, the S&P 500 Index extended its streak to 9 consecutive positive quarters by eking out a gain of 0.5% in the first quarter. In fact, the S&P 500 has not experienced a quarterly decline since 4Q, ‘12. A string this impressive has not been seen since the mid-1990s when the broad market index registered 14 consecutive positive quarters.1
Although streaks are mathematical irregularities, always coming to an end, the performance of the US stock market over the last 6 years has been both steady and inspiring. Since 2009 the S&P 500s’ almost 200% gain was due partially on the aggressive monetary support from the Federal Reserve, valuations, and high profit margins driving earnings and multiple expansions.
In the 1st Q, 2015, growth stocks outperformed value as the prospects for a higher interest rate and slower growth environment favored companies with higher growth rates and valuations. This is not uncommon at this stage of the investment cycle. The Russell 1000 Growth Index outperformed the Russell 1000 Value Index by 4.5% in the first quarter. Mega cap stocks also lagged their smaller partners. The rapid rise in the US dollar adversely affects larger companies which tend to have more multinational operations. At the sector level, performance did not follow cyclical or defensive generalizations. Health Care, Consumer Discretionary and Telecom were strong while Financials, Energy and Utilities fell.2
Effect of Oil Drop
The recent oil decrease has investors questioning the significance moving forward. The drop in oil price was precipitated by the principals of supply and demand: with technology enhancements and shale discoveries in the U.S., production has increased about 60% in the last 5 years from 5.5 million barrels per day to almost 9 million barrels per day. This increase in production led to a decrease in U.S. import and an overproduction gluttony.3
At the same time, world oil consumption and demand slowed down significantly. Although there are positives and negatives with oil prices this low, experts see an overall net positive. Reduced oil prices are good for consumers and leave more money available to spend each month. This would have a positive effect on sectors of the economy that benefit from lower oil prices like transportation, retail and industrial.
Volatility in 2015?
1Q, 2015 was marked by an increase in market volatility. The DJIA witnessed 16 triple-digit moves during the month of March—the second-most of any month in history (October 2008 experienced the most). Investors were torn between the news that the European Central Bank (ECB) had finally launched its quantitative easing program and the Federal Reserve bank's plans to begin hiking rates, possibly as soon as June. Perhaps as influential on investors were the wild fluctuations in oil, currency, stock prices, and the ever-present concern about conflicts in the Middle East.
With that being said, most of the major indices posted positive returns for Q1, with the small cap-oriented Russell 2000 Price Only Index once again posting the strongest return of the group (+3.99%), followed by the NASDAQ Price Only Composite (+3.48%) and the S&P Industrial Price Only Composite (+1.57%). For the quarter, the average equity mutual fund posted a 2.56% return, with Lipper's World Equity Funds macro-classification (+3.36%) jumping to the top of the leader board for the first quarter in six.
Most economists believe that the Fed rate hike is inevitable this year. One indicator for future rate hikes is seen by monitoring the interest rate futures. Market watchers believe that there is a 70% probability that interest rates will go up in 2015 and end the year between 0.5% and 0.75%. Currently the Fed Funds Rate is at 0%-0.25%. Consensus points to the Fed starting to gradually increase rates this summer but if global economic growth decreases the Fed may continue to be “patient” on the rate hike. At this point we don’t anticipate rapidly increasing rates4.
Bonds have 3 main uses in a portfolio: increasing stability (lowering volatility), providing a stream of income, and increasing liquidity. Of those three, the most important thing they have done since 2007 is to provide security when markets pulled back; rebalance portfolios and sell some bonds as they have gone up and buy some stocks as they have come down (and vice versa). We continue to keep our eye on the Bond market to make sure our portfolios are properly equipped.
Emerging Markets Hampered by Strong Dollar
The dollar's rapid rally—the fastest in 40 years—is great for the American traveler, but harsh on foreign countries and big businesses overseas. On top of currency worries, developing countries are also facing political problems, fears of a Federal Reserve rate hike and the commodity bust. The result is that investors are turning their back on emerging markets and only put $16 billion into emerging market stocks and bonds in March. Since 2010, emerging markets have averaged about $22 billion per month.
Unemployment Rate and its Market Effects
Total non-farm payroll employment increased by 126,000 in March, and the unemployment rate was unchanged at 5.5 percent. Employment continued to trend up in professional and business services, health care, and retail trade, while mining lost jobs. 5 The number of job openings is also at a high level, a further indication of more hiring to come. The gains will fuel consumer and business confidence and lead to consumer spending and, later on, rising wages. Experts expect that eventually job gains will slow to a more sustainable level as the unemployment rate nears 5%, but that probably won’t happen until 2016. Experts expect unemployment rate to finish the year at 5.3%. While the rate stayed at 5.5% in March, the number of long-term unemployed—out of work six months or more—continued to fall. Because the number of short-term unemployed is already at a low level, most of the future decline in the jobless rate will come from further reductions in the long-term ranks. As the unemployment rate continues to decline, employers will feel pressure to hike wages. Wage growth is likely to bump up a bit, to 2.2% by the end of the year, after running at about 2% for most of the second half of 2014.
The Rest of 2015
While the recent, sharp drop in oil prices has caused some alarm in the market, we believe cheaper oil is a net positive. Markets have also shown an increase in volatility which is likely to continue in 2015. While increases in volatility usually go along with increased fear among investors, history has shown that times of heightened fear have been good times to buy. Further, times when markets take wild swings up and down have favored our proactive approach to strategically rebalancing portfolios, while attempting to take advantage of pricing anomalies. We encourage our clients to keep a long-term investment perspective in mind and try to avoid the temptation to allow short-term market movements to drive you to make emotionally based decisions regarding your investments. While stocks provide long-term growth potential, bonds have served their role in protecting capital, reducing volatility and providing income.
Spring is the time of renewal, Opening Day of baseball, and migrating birds. Do you ever wonder why birds come back north in the spring? It takes a great deal of energy to migrate back and forth, and there are many risks along the way. A lot of birds don’t make it. It turns out that there are some real advantages to making the trip north. Spring migrants time their return to coincide with a virtual explosion of food resources. As the cold northern states emerge from the grip of winter, virtually every local plant and animal begin to reproduce, and it’s not long before there is a huge abundance of seeds, fruits and invertebrates. Migrant species take advantage of these resources to have their own young. Birds, it seems, are not that different from savvy investors. Where there is abundance, there are opportunities. Now is the time to review your retirement account to determine if you are well prepared to take advantage of the Market opportunities when they present themselves.
Happy spring and play ball!
David A. Krasnow
The information contained herein has been compiled from sources Pension Advisors, Inc., believes to be reliable but no warranty, expressed or implied, is being made that the information is complete or accurate. Information presented is not an offer to buy or sell, or a solicitation of any offer to buy or sell any securities which may be mentioned herein. All securities are subject to price and yield change and subject to availability. Any recommendations or opinions expressed herein may be subject to change without notice. Past performance is not guarantee of future results.
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The story about the U.S. economy remains positive. Unemployment seems to have reached a trough just below 4% while not leading to horribly negative effects on productivity, and showing mild wage inflation, concentrated in certain areas of the economy.Read full story here