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Wall Street to Your Street
April Recap: Times a-Changin', Oil Flows While Technology Slows
May 3, 2016 | Gene Walden
"The slow one now will later be fast ... and the first one now will later be last." Bob Dylan's famous refrain is an apt description of the April stock market, which was led by the four weakest sectors of the past year: energy, financials, materials and health care.
On the flip side, utilities, which had been the best-performing sector through the first quarter of 2016, was one of the three worst-performing sectors in April, along with telecommunications and information technology.
Also trailing the market were some of the leading technology stocks, which had paced the market last year.
We believe much of the movement in those sectors can be attributed to sector rotation, with investors easing out of growth stocks and into value stocks. But overall, most of the movement in the S&P 500® Index was sideways throughout most of April, although the market managed to eke out a slight gain (0.3%) for the month.
A weak first-quarter gross domestic product (GDP) report issued by the U.S. Commerce Department on April 28 precipitated a slight drop in stocks during the final day of the month. The GDP report, which is the broadest measure of economic output, revealed that GDP had grown at a seasonally adjusted annual rate of only 0.5% through the first quarter of 2016. That was the lowest GDP growth level in the past two years.
In a nutshell(Exhibit 1)
April fly-over: FANG phenomenon fading?
Notable stocks of 2015 included an exclusive quartet of technology titans known to the investment community by the acronym "FANG" – Facebook, Amazon, Netflix and Google.
But this year, FANG stocks, as well as some other notable technology mainstays, have struggled – with several dropping by double-digits. While we believe normal sector rotation has played a part in the price decline, several technology leaders, such as Apple, Microsoft, Expedia and LinkedIn, have fanned the flames in recent weeks with disappointing financial reports. Here's how the year has shaken out so far for some of the leading tech companies:
Other economic highlights from the month
Employment numbers still solid
Employment has been one of the bright spots of the economy in recent months, and the
April Employment Report from the U.S. Department of Labor brought more good news.
According to the April report, nonfarm payrolls were up 215,000 in March following
a gain of 245,000 in February.
But the number of new jobs fell short of the number of new individuals now looking for work. The labor force grew by 396,000, according to the report, which was considerably higher than the number of new jobs filled. The estimated number of new jobs for the first quarter of 2016 was 628,000, which is slightly above the quarterly average of about 610,000 per quarter since the job market began to recover in 2011.
We believe the increase in the number of new jobs and the trend of more people entering the work force is a good sign for the economy; however, there remains substantial room for improvement in labor conditions.
Federal Reserve makes no moves
Dollar continues to drop
China does better
By the numbers
S&P 500 continues to edge up
The best performing sectors in the S&P 500 Index for the month of April were energy, up about 9%, and materials, up 5%, and health care and financials, both up about 3%. Industrials were up 1% for the month.
The worst performing sectors were information technology, down about 5%, telecommunications down 3% and utilities down about 2%. Consumer staples finished the month down 1%.
Consumer discretionary sector was even for the month.
Equity earnings projections flattening out
According to Standard & Poor's, forward aggregate earnings for S&P 500 companies has been dropping slowly this year, from about $127 at the start of the year to $124.36 at the end of April (Exhibit 3). We believe that the $124.36 projection is still somewhat optimistic, and that the real earnings numbers will be slightly lower.
Forward price-earnings ratios
The forward 12-month price-earnings (P/E) ratio for the S&P 500 ended April at 16.75, up slightly from the 16.4 level at the first of the month. It is also up from the 16.1 P/E ratio at the start of 2016 (Exhibit 4).
While the 16.75 P/E level is still within a reasonable range based on historic levels, we consider it to be fairly high considering the slowing growth rate of corporate earnings.
Equity earnings yield
The forward 12-months earnings yield for the S&P 500 barely moved during April, beginning the month at about 6% and ending the month at the same level, according to Standard & Poor's (Exhibit 5). Although the equity earnings yield is still well above the yield on 10-year U.S. Treasuries (which is about 1.9%), it has declined steadily since 2011 when the yield reached as high as 7.4%.
Bond market: Fed holds the line on rates
The Federal Reserve did not act on a rate change during its April 27 meeting, so the Fed interest rate remains unchanged.
The U.S. bond market has fallen into the range of negative "real" interest rates this year, as market rates paid on 10-year U.S. Treasuries have been less than 2% since Jan. 27. That is below the 2.2% rate of inflation in the U.S. through the first quarter of 2016.1 The "negative real interest rate" is defined as a bond or debt instrument yield below the current rate of inflation.
But overseas, central banks have issued a wave of government bonds with true "negative interest rates" that yield less than 0%. (Negative interest rates refer to a monetary policy in which bank deposits and government bonds actually return less than the investor deposits.) In all, about $7 trillion in government bonds now carry "negative interest rates." The leading issuers of negative rate bonds are Germany, Japan and Switzerland.
This extreme policy pursued by the central banks in Europe and Japan is intended to stimulate economic growth, but in our view, it has shown little evidence of success to date.
Not only is it hurting the banking industry – since banks are unable to make money on deposits because they receive a negative yield on the government bonds they buy – it has also had the effect of slowing down consumer spending. With negative interest rates, consumers now believe they need to stash even more cash to compensate for the negative rates. They are saving more now instead of spending.
Dollar continues descent
As the graph shows, the dollar declined versus the yen through the first four months of 2016, while the graph on the right shows the euro also gaining ground on the dollar through the first four months of the year after a prolonged period of losing ground to the dollar over the past two years (Exhibit 7).
If the dollar continues to decline versus the world’s other leading currencies, it would be a boon to U.S. manufacturers who could market their products more competitively overseas.
However, because of the economic weakness in both Europe and Japan, we are skeptical that the recent downward trend in the value of the dollar will be sustainable over an extended period.
Oil & gold keep moving up
As the graph illustrates, oil prices have continued to trend upward from their recent low of under $27 a barrel on Feb. 11 (Exhibit 8). After starting the month at about $37 a barrel, prices moved to more than $40 a barrel in early April and finished the month at around $45.92 a barrel.
We believe the strength in the oil market is due to supply moving in line with demand after many months of overproduction. Production has slowed as prices dropped, with the higher-cost producers forced to curtail production. We believe that supply and demand will likely be in balance by the end of this year.
While we expect the price of oil to continue rising, we do not expect it to go back up to $100 a barrel anytime soon. With shale producers and other suppliers waiting to jump back into the market at the right price, we expect that the lid on oil prices will be at about $70 to $80 a barrel over the next couple of years.
As the graph illustrates, gold continued to trend upward in April, continuing a pattern that has characterized the entire year so far (Exhibit 8). After ending 2015 at $1,020 an ounce, the price of gold ended the first quarter at $1,222, and continued to trend up to $1,295.40 by the end of April.
As the graph illustrates, the global equities market (as measured by the EAFE Index) made a modest gain for the month, moving from 940.1 at the close of trading March 31 to 960.3 at the end of April (Exhibit 9).
While economies throughout Europe remain sluggish, China reported that its economy is stabilizing in its first-quarter GDP report in April, with GDP growing at an estimated annualized rate of 6.5%.
The emerging markets also showed some positive movement, which we believe is due, in part, to an improvement in commodities prices.
Fast-forward: Outlook for the markets
Although 2016 has gotten off to a fairly positive start, there are headwinds that could impede stock market growth – and a few tailwinds that may work in the market's favor:
Our economic expectations
We continue to believe that the GDP growth rate will be lower this year than it has been the past few years. The consensus among analysts for GDP growth for this year is 2.1%, according to the Blue Chip Economic Indicators, but we project GDP growth at 1.5% to 2.0%.
Globally, over the next 12 months, we continue to believe that China will have GDP growth of about 6.5%, Japan will have negative growth, Europe will experience growth of just less than 2%, and the United Kingdom will post GDP growth of 3% or more.
The economic slow-down suggests the risk of recession is not insignificant. But, we also believe a recession can be avoided, particularly if China continues to rebound, rising oil prices continue to recharge the energy sector and employment remains strong.
Either way, to steal a line from another notable Minnesota musician, "I know, I
know times are changing ... purple rain, purple rain."
Contributing to this report: Russell Swansen, Chief Investment Officer; David Francis, CFA, Head of Equity; Mark Simenstad, CFA, Head of Fixed Income; John Groton, Jr., CFA, Director of Equity Research; Darren Bagwell, Sr. Equity Portfolio Manager; and Jeff Branstad, CFA, Senior Investment Product Strategist
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Media contact: Callie Briese, 612-844-7340; firstname.lastname@example.org
1 The core inflation rate is a combination of the core Consumer Price Index, or core CPI, and the core Personal Consumption Expenditures price index, or core PCE price index, as determined by the U.S. Bureau of Labor Statistics.
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