Will Springtime Arrive on Wall Street?
The last Ryan Report, written January 15th, was entitled “What a Start!”, of course referring to the New Year’s tumultuous decline in stock markets throughout the world. Fueling the decline was the collapse in oil prices which further worried investors as to the financial health of banks who had lent hundreds of millions of dollars to petroleum companies for drilling and exploration. As the per barrel price declined into to the high $20s, exploration came to a virtual standstill. Layoffs and bankruptcies ensued and investors’ moods changed from concerned to terrified.
In that January report we reminded out readers that “…we have been to this movie before.” We were of course referring to all of us having previously experienced violent changes in petroleum prices and that markets eventually righted themselves. “Supply gluts have always reversed themselves and prices have resumed their climb. Right now at $30/barrel, existing wells can continue to pump, but virtually all exploration is in mothballs. Petroleum will self-correct!”
Here we are some eight weeks later and per barrel prices are up over $42 and the industry has stopped contracting, even netting one new oil rig last week. Stock markets have responded, as we predicted they would, with a five week rally that has pushed all the major averages into positive territory for 2016. Eight weeks ago the pessimists would have called that a pipedream. Last week alone the Dow Jones Industrial Average gained almost 400 points as oil prices surged.
Another reason for the newfound optimism is that in January several members of the Federal Reserve were suggesting that we might see four interest rate boosts this year. Ryan Financial suggested that cooler heads would prevail and fortunately they have. The latest guidance is that we may see only two. The Fed is well led, but is always subject to political pressure. As long as they stay “data dependent” we will be fine. There is zero chance of inflation being a near-term problem so Fed action in that regard is unnecessary and unlikely.
Within the next four weeks companies will begin to announce their first quarter earnings and that could be the next hurdle for the markets. The next group of corporate earnings are likely to be about 7% behind the first quarter of last year. The price/earnings ratio of the Standard and Poor’s 500 based on estimated Q1 profits is about 17, which is on the high side of normal. The silver lining is that the recent spurt in stock prices has been mostly in the growth stocks. Value stocks have been lagging and there is a high probability that the value stocks will catch up. It doesn’t matter whether growth or value leads the way. The laggard almost always closes the gap. With interest rates near their historical lows, everyone loves those high stock dividends that the value shares pay.
The other wild card in the mix is the labor market. Underneath the seemingly healthy unemployment figures is a cauldron of angst. There was a political cartoon last week that portrayed the folly of looking at the 4.9% figure as representative of the real situation. The cartoonist framed his thesis through the eyes of the anti-fossil fuel crowd. The headline bellowed “Kill one $40/hour coal miner’s job and create three $8/hour jobs; net two new jobs”.
Barron’s notes last week that the Fuqua School of Business at Duke University surveyed the CFOs of hundreds of firms, large and small, as it relates to the imposing of a $15/hour minimum wage. Three quarters of the CFOs said they would trim current or future payrolls. 41% said they would lay off current workers and 66% said they would slow future hiring. Campbell Harvey, the survey’s author said, “CFOs are telling policy makers that there is a significant unintended consequence; some jobs will be replaced by robots, and this replacement is permanent.”
The political landscape is also doing little for consumer confidence. The likely prospect of a Clinton versus Trump contest is causing a robust case of voter indigestion. Given that the Republican elite are trying to derail Trump’s march adds even more fuel to the fire.
The final facet to consider is that central banks worldwide are trying to create more easy money and that should eventually ease investors’ anxiety.
The rally could continue and likely will if oil prices continue to recover. On the other hand, if they soften the market could take a pause and wait for first quarter earnings to provide guidance. Keep in mind that the consumer is the key. If he and she feel comfortable, spring will arrive right on schedule. If not, keep the snow shovels handy.