There is widespread uncertainty about the outlook for the U.S. economy and the stock market reflecting concerns about China, Europe, the dollar and the decline in the price of crude oil. Investors have also had to assess the impact on the economy and markets of the actions by the European Central Bank that has been cutting rates while the U.S. Federal Reserve has taken the first step toward raising rates.
The IMF and the World Bank continue to warn that the global economic recovery remains too slow and fragile. Their concern is that government fiscal and monetary policies have exhausted their effectiveness to deal with stagnant economies. Also they have ended up driving investors to take on greater and greater risks in the search for higher yields. The bank and others have warned that the world risks being trapped in a “new mediocre” of persistent low global growth.
The Federal Reserve acted out of necessity in the fourth quarter of 2008 to flood the banking system with programs of unprecedented monetary accommodation to stabilize financial markets. What was probably intended to be a temporary intervention by the Fed continued for years so that markets began to become dependent on the Fed policy of easing. This continued until December, 2015 when the Fed announced the beginning of a shift to normalize monetary policy and its intention to move away from its zero interest rate policy. The yield on U.S. Treasury 10 year bond is now 1.78% compared with 3.0% in mid-2014.
By contrast, global central banks have been pushing negative interest rate policies in an attempt to deal with deflationary trends in their economies. Negative bond yields guarantee investors a loss if held to maturity. Sweden, Switzerland, Denmark, Japan and Germany have introduced negative interest rate policies. This week the average yield for German government bonds fell to zero for the first time in history.
Investor emotions are bombarded daily by reports of unprecedented terrorist attacks, economic turmoil throughout the world and angry charges by the presidential candidates reported in the news media. Over the short-term, emotions drive stock prices, but in the long term, corporate fundamentals determine the course of stock prices. With all that has been happening, the market has held up reasonably well. In many global markets, stocks have recovered from February lows and are about unchanged for the year to date.
U.S. stocks are not cheap, but are selling in line with their long term average valuations. Our perspective is that business conditions and corporate earnings will begin to improve later this year. As a result, we maintain a positive long-term outlook for equities. The market has been trading sideways for the last two years and while the market index doesn’t seem to offer much potential, we find value in quality stocks that are undervalued relative to their long-term intrinsic value.
After the slow-down from the impact of oil prices dropping and dollar strength, U.S. GDP growth is expected to rebound and grow at a 2.0% rate for 2016, with little prospect of a recession. We believe that growth, albeit at a low rate, could be sustainable for years to come.
The unemployment rate is now 5.0% and an average of 200,000 jobs have been added in the private sector over the last 66 months, with continued growth expected.
With interest rates being maintained at historically low levels and many shifting towards what they think are low risk investments, we believe long-term investors will be rewarded by focusing on selected equity opportunities which can be held through these times of heightened uncertainty and turbulence.
Note: We have gathered the information contained in this report from sources we believe reliable; however, we do not guarantee the accuracy or completeness of such information. You should not assume that any discussion or information contained in this market commentary serves as the receipt of or as a substitute for personalized investment advice from Whitnell & Co. No part of this publication may be reproduced in any form, or referred to in any other publication, without express written permission.