Washington Trust Bank Blog | Market Volatility Continues

Market Volatility Continues

After a rocky week, equities began this shortened week with a strong showing, with the S&P 500 gaining 1.7%. That leaves the S&P, down 6.9% YTD. Any way you slice it, it has been an uncomfortable way to start 2016. As such, I’d like to briefly discuss the main issues that have raised investor anxiety.

Last year the US economy grew 2.4%; however, 4^th quarter growth slowed more than expected. The slowdown was due primarily to an inventory drawdown, an increase in the trade deficit, and mild weather reducing spending on utilities. As you probably noted, much of this is transitory. On the other hand, unemployment declined, wage gains were finally strong, and job openings were high – all pointing to strength. Manufacturing, which has been hurt by the strong dollar was positive – barely (.8%) – but still positive. One must remember that only 8% of the US is employed in manufacturing, so it may not be a good barometer on overall economic health.

Energy prices have created earnings problems for the energy sector and that has bled over to the S&P 500 as a whole, but comparisons to real estate and our recent crisis are a stretch to say the least. While the low prices are a negative for producers, they are a positive for consumers and, in the US, we consume twice as much as we produce.

Because of low energy prices, banks have recently come under pressure, especially in Europe due to the fear of nonperforming loans. US and European banks are much better capitalized and less leveraged than they were during the real estate crisis, but the European banks are certainly less well off than US banks. While the exposure to the energy sector is similar, US banks are better capitalized and, we may see European banks selling assets to improve their capital.

In China, growth, as we have stated, has slowed and is normalizing. 6.9% growth, while substantial for the developed world, is below their 30-year average. To reduce the slowdown, China initiated its own form of stimulus last year and we believe China will do whatever it takes to stave off a hard landing. Stability is the primary goal of the Communist party and, as the world’s largest holder of foreign reserves, they have the resources to keep the economy growing for the foreseeable future.

Last week, Chairman Yellen did not reduce uncertainty, never a positive for equities, when she said the Fed would take a wait and see attitude to raising interest rates. Basically, this is the only position the Fed could take but because fear pervades, the interpretation went from, the US economy has weakened so much that rates cannot be raised, to the Fed is going to raise rates and force the economy into recession. Neither, is a reasoned assessment.

Due to the selloff in equities, stocks have become cheaper. If you look at the relative price of stocks to Treasuries or the forward P/E ratio, stocks do not look expensive; however, if you look at Shiller’s P/E ratio, stocks are still not cheap. Regardless, none of these measures is a good indicator of what will happen with stocks in the coming year. The selloff, however, raises anxiety and this, in and of itself, could increase volatility in the near term. This only emphasizes the need to stay diversified, with risk management as an integral part of your portfolio.

In short, the fundamentals don’t seem to justify the recent selloff, but emotions rule the markets in the short-term. As fear has taken over market psychology, we need to be prepared for a turbulent period.

 

Washington Trust Bank believes that the information used in this study was obtained from reliable sources, but we do not guarantee its accuracy. Neither the information nor any opinion expressed constitutes a solicitation for business or a recommendation of the purchase or sale of securities or commodities.

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