March ended the first quarter of 2016 on a positive note with equity markets staging an impressive rally, yet the 7-year old bull market remains in a tenuous position. Although developed market equities rallied around 7%, the S&P 500 is barely positive year-to-date and developed markets outside of the U.S. are under water. Emerging markets have been the best performing geography thus far this year, rallying 13% in March and are up more than 5% year-to-date.
The chart below highlights just how choppy the quarter was. Most broad indices traded in a 10% range, only to end the quarter roughly flat. Detailed asset class performance is available here.
Sources: Bloomberg and Covenant Investment Research
Once again the rise in equity prices was less about dramatically improving economic fundamentals (see Show Me the Money below) than it was central bank actions. For example, in March the European Central Bank launched another round of QE (that included pushing interest rates further into negative territory), the Bank of England held interest rate levels static, and the Fed (in addition to not raising interest rates) crafted a very dovish message that reduced the number of expected interest rate increases in 2016 from 4 to 2. Clearly no central banker is ready to remove the punch bowl just yet.
And why would they? Both Japan and the European Union economies are on the cusp of outright deflation. While growth in the U.S. economy is well below average, it is the envy of developed markets the world over. Moreover, with such a low growth rate, the U.S. economy is uncomfortably susceptible to global dynamics. A point that Fed Chair Janet Yellen acknowledged in her recent remarks. So….. it looks like the extraordinarily accommodative monetary policies will be with us for the foreseeable future.
Show Me the Money: Historically, corporate profits have been a very good leading indicator of economic activity and stock prices. Unfortunately, profit data over the last 21 months are signaling a warning sign as they have been in a downward trend since the mid-point of 2014. Moreover, retained earnings are declining at a faster pace than profits as management teams direct idle cash to stock buybacks and dividends that, while economically unproductive, serve to support their company’s stock price.
Source: FTN Financial
Corporate profits are not a perfect indicator of future economic growth nor the direction of stock prices. Yet, as the chart above illustrates, there is a strong relationship between them. As such, some caution is warranted until corporate profits reverse their current trajectory.
Economic Data Summary: Consumption growth continued to expand (+0.2% month-over-month (m/m)) in February, albeit it at a slower pace than in Q4 ’15. This was not a big surprise, given the downward revisions to Retail Sales a couple of weeks ago. The Conference Board’s measure of U.S. Consumer Confidence rebounded from February’s reading of 94 to 96.2 in March. More importantly, the forward-looking expectations sub-index jumped to 84.7 (from 79.9), which may portend a pick-up in consumption as consumers generally feel good about the future. Some of that confidence is likely stemming from the solid labor market, which added another 215,000 jobs in March. The manufacturing sector showed signs of life in March as the ISM Manufacturing Index rose to 51.8 after languishing for five months below 50 (a reading below 50 indicates a contraction).