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Expert Perspective

News, research and market insights from our team of experts.

Investment e.Perspective

Current Issue | April 27, 2017

Is It Safe…?

By: Mark M. Green, CFA, Chief Investment Officer and Oxford Investment Fellow


With the first quarter of 2016 behind us already, investors are naturally looking ahead to see where asset prices move next. Based on the roller coaster ride of the first quarter, it's anybody's guess – underscoring the pitfalls of focusing on short-term market movements. We view the financial landscape through the longer-term lenses of economic fundamentals, market valuation and macro event developments. We comment on our perspective often in these pages and, frankly, the scenery doesn't change much from one Investment e.Perspective to the next. Like the seasons, markets move through cycles that can be difficult to discern on a day-to-day basis. Yet new information does provide more detail for the overall picture and at the margin things are constantly changing.

The IMF recently downgraded their outlook for global growth in 2016, again, based on generally sluggish performance so far. The US remains the bright spot, however, relative to much of the rest of the world. Even so, a new and more timely forecasting tool from the Federal Reserve Bank of Atlanta suggests real growth in US GDP slowed significantly during the first three months of the year, perhaps to less than a 1% annual rate in real terms. That is consistent with the outlook for corporate profits in the first quarter, which companies are just beginning to report.

Following continued downward guidance from company executives, Wall Street analysts expect another drop in earnings for S&P 500 companies as a whole – possibly the steepest since the Great Recession. That would mark the sixth quarter in a row that earnings-per-share for the index declined on a year-over-year basis. Moreover, an "earnings recession" is often accompanied by an outright economic recession, completing the feedback loop. We've read a lot more in recent weeks about the potential for a recession than we have for some time. That isn't part of our baseline outlook, but the probability seems to be rising and we can't ignore it.

In light of the "recovery" in stock prices over the past several weeks, continued weakness in corporate earnings will further highlight valuation concerns, especially for US equities. The overall bond market is no great bargain either with interest rates already at historically low levels (negative in some cases) and spreads for corporate and high-yield bonds having tightened significantly in recent weeks. Bonds are an effective hedge for stocks, however, and are a key element in diversifying portfolio risk. Safety assets are worth their price when you need them, especially those with the highest credit quality. Our concerns over valuation in both of these primary markets have been well documented and aren't likely to go away anytime soon.

Global central banks are already doing everything they can to stimulate growth, stave off deflation and keep the financial markets in balance. One of the "macro events" we've been concerned about is how the Federal Reserve would manage their so-called liftoff and gradual tightening of credit conditions in the US. They took a pass on their chance to raise interest rates again in March, and recent communications (minutes from previous meetings, speeches by Fed officials, etc.) have had a decidedly dovish tone about them. While the Fed often leads other central banks in managing monetary policy, they probably don't want to get too far away from the herd for fear of creating disruption in the capital markets. In some respects, they are in a conga line with the Fed at the front, holding an angry tiger (or bear) by the tail.

One interesting development of late has been the surge in prices for commodities and natural resources, most visibly oil. It remains to be seen whether this shift reflects improved supply/demand fundamentals, a massive short covering rally or both. However, its correlation with rising equity prices in other sectors of global markets – emerging markets and natural resource producers in particular – reveals how interconnected these markets can be.

This month in the Investment e.Perspective we have two additional articles focused on recent dynamics in the capital markets. In the first article, Bob Schaefer provides a review of market performance during the first quarter, an insightful market cycle perspective and offers some general portfolio advice going forward. In the second article, Brendan O'Sullivan-Hale analyzes the first-quarter bounce in emerging market equities and its connection with the commodity/natural resource markets. A common theme between these two articles: Is it safe to go back into the woods again?

The above commentary represent the opinions of the authors as of 4.18.16 and are subject to change at any time due to market or economic conditions or other factors.