How much does what happens in January matter?
According to CNBC, over the last 35 years, what the market does in January has predicted how things will turn out for the rest of the year 71% of the time (as measured by the S&P 500).
But that statistic reflects a much better job of predicting winners than losers, because markets are biased toward the upside.
Consider this: The S&P 500 Index has risen in 23 out of 35 Januarys since 1979. Over the next 11 months, the market rose in 19 of those 23 years—meaning a positive January successfully predicted a winning February through December 83% of the time.
But in years when January lost ground, there was only a 33% success rate in predicting a losing year.
There are plenty of reasons markets go up or down, and plenty of interesting but meaningless correlations, including whether the AFC or NFC team wins the Super Bowl this weekend (http://fortune.com/2016/01/20/super-bowl-predictor-2016/). So I don’t necessarily believe that January sets the tone for the year.
Over the longer term, it’s about corporate profits. The S&P 500 and corporate profits have a correlation of 95% over the last 100+ years, and right now corporate profits are barely growing.
Markets don’t rise in a straight line. So this is a typical correction, only it’s getting big headlines because it’s happening at the beginning of the year.
Why the poor start?
Economic growth slowed at the end of the 2015. Gross domestic product (GDP), the largest measure of economic activity, slowed from an annual rate of 2.0% in the third quarter to 0.7% in Q4 (preliminary data from the U.S. Bureau of Economic Analysis).
That has in turn forced analysts to cut back their forecasts for S&P 500 profit growth in 2016. Last November, analysts were forecasting a rise in Q1 profits of 3.6% (Thomson Reuters). By the time January ended, the increase had evaporated and analysts now foresee a drop of 2.7%. Losing ground in Q1 would make it the third straight quarterly decline.
The effect of oil prices
A huge part of the market’s weakness has to do with the near collapse in energy profits. It’s been great at the gas pump, but the losses in the energy sector have been a net negative for the economy, with steep cutbacks in oil and gas projects. Those cutbacks have in turn negatively affected manufacturing.
The reasons for the oversupply of oil and the steep price decline are too much to get into here, but a good overview is in this New York Times article: http://www.nytimes.com/interactive/2016/business/energy-environment/oil-prices.html?_r=0
Lower oil and commodities prices may eventually end up increasing discretionary consumer spending – remember that the U.S. consumer is still about 70% of the economy – but that could take some time to see.
What the strengthening dollar means
The strengthening dollar is affecting sales and revenue for U.S. firms that do a lot of business overseas. A strong dollar is great if you’re planning to travel abroad, but it works against revenues for American firms because sales in local currencies have to be translated back into the stronger dollar. So this is another factor affecting corporate profits.
Will interest rates go up again?
The odds of another increase in March are slim, based on the Fed’s statements from their January meeting. They have somewhat downgraded their outlook on the economy, based on softer net exports and increases in manufacturing inventories. The Federal Open Market Committee is also less confident about reaching its inflation target of 2% (it’s trending lower than that), which they consider most consistent over the long run with achieving their mandate of price stability and maximum employment.
Looking ahead
Volatility is normal part of investing. A more aggressive portfolio can create better returns over the long term, but it will see higher highs and lower lows.
A more conservative approach can smooth out, but not eliminate, volatility. It may not capture the same returns over the long term, but it will allow the more risk averse to sleep better at night.
This might be a good time to review your goals and go over your portfolio. We can always adjust things based on your risk tolerance or a change in your goals or circumstances.
A recession, many believe, should be avoided this year. Housing is doing fine, consumers are buying, and wages are starting to go up – all good, steady indicators of general economic health. But the volatility is going to stick around for a while.
I hope you’ve found this review to be educational and helpful. If you have any questions or would like to discuss anything, please feel free to give us a call.
