May 3, 2016
The December malaise awakened explosively to start 2016. The market correction that had been held back by managers’ push for returns in December let loose in January as the S&P 500 index corrected over 10% to start the year. Fluctuations were extreme as algorithmic trading had an outsized effect on volatility. Ultimately, however, the overly aggressive correction and a modicum of fundamental economic improvement stabilized markets, with the S&P closing the first quarter essentially flat (+77 bp).
Economic conditions continued to deteriorate at the start of the year. Contracting YoY earnings, weak US and Chinese economies, uncertainty surrounding interest rates, depressed oil prices, and volatility in high yield bond markets were not offset by material strength elsewhere. The yield curve continued to flatten following the first rate hike in December, and the ECB continued its QE while the Bank of Japan recently cut rates to negative. This put upward pressure on the US dollar, tightening the stranglehold on manufacturing and export earnings. Accordingly, markets corrected.
By mid-February, a number of developments helped to stabilize markets. In the immediate term, the S&P 500 held support at 1812, a level bolstered by the fact that market valuations were oversold at those levels. A confluence of positive technical indicators and the influx of computer-driven programs sparked the action. And in the medium term, moderately improved economic data, a rebound in oil and other commodity prices (suggesting commodity price stabilization, and helping to stabilize high yield bond markets), and good corporate pre-announcement news turned the negative feel around in a pronounced fashion.
In the long term, a number of significant concerns persisted heading into April. Corporate profits are anticipated to be weaker in Q2, and the market recouped its losses dramatically despite the global economic indicators failing to improve to the same degree. The story is therefore one of corporate earnings and broad economic strength or lack thereof, as both elements must show enough strength and stability to justify market strength heading into Q2.
The following indicators are representative of the overall economic climate in the first quarter of 2016.