April 2016 Monthly Outlook
Most of the key economic benchmarks—from job growth, to new home sales, to the leading indicators—now are holding steady following softness late last year and in the first few weeks of 2016.
“The U.S. LEI (leading economic index) increased slightly in February, after back-to-back monthly declines, but housing permits, stock prices, consumer expectations, and new orders remain sources of weakness,” said Ataman Ozyildirim, Director of Business Cycles and Growth Research at The Conference Board. “Although the LEI’s six-month growth rate has moderated considerably in recent months, the outlook remains positive with little chance of a downturn in the near-term.”
The core CPI continued its increase as it rose 0.1% in February. Despite the increase above the Fed inflation target of 2%, based on the dovish tone adopted at the March Federal Open Market Committee meeting, the Federal Reserve is likely to remain supportive for some time. The lead bank pointed to the risks posed by an uncertain global outlook and the high stress levels, which have now risen in the wake of the tragic attacks in Brussels, in the world’s financial markets as reasons to proceed slowly. Irregular business activity at home may induce the Fed to act cautiously as well. The caution expressed by the Fed Chair Janet Yellen and the absence of rate increases at its two meetings since December’s gathering imply that the central bank may wait a little longer before resuming its tightening efforts. Investors have taken well to the Fed’s indicated patience.
Indicators point to the US economy growing slowly (~2% annually) and being in the late stages of a long business up-cycle without major excesses that brought down some prior economic upturns.
Stock and Bond Market Commentary:
US large cap stocks had a strong March as the index increased 6.72% for the month, allowing the index to return 1.32% for the quarter. On February 11th, the index was down as much as 10.5% year to date, so the markets have stormed back 11.82% in the last six weeks. Market rallies during bear markets are historically sharp and short lived. I would expect this current momentum to stall out similar to the way it did last November. One of the reasons for the market stall since 2014 is that corporate earnings growth peaked in late 2014. In Q4 2015, US corporate earnings growth was -7% or -1% if you exclude the energy sector.
Our more aggressive portfolio strategy performance was dragged down because of an overweight allocation to healthcare sector stocks, the worst performing market sector which decreased 5.57% in Q1. This sector has been hit because of bad publicity and political comments on price controls that have really spread fear through the biotech industry. Price control would limit the ability of companies to recover the expenses that come with creating treatments and to make a profit on the few that make it through the approval process.
However, there are several reasons why the health care sector will continue to offer long term market beating results in the future. First, health care spending is rising 6% per year. Second, earnings in the health care sector are expected to rise 10% in the coming year, beating the earnings expectations of the market as a whole. Lastly, demographics should not be forgotten. In a recent article by Kaiser Health News, baby boomers will live longer but will have poorer health doing so. They will suffer from chronic illness, obesity, hypertension, etc. These illnesses will drive more spending on Medicare to an estimated $1.2 trillion by 2030. This sector is expected to continue to have the highest future earnings growth over the next 3-5 years, so this decrease in market prices makes the current valuations in this sector highly attractive relative to other market sectors.
Evidence of market history strongly suggests we are in the relatively early stages of a full-scale bear market, therefore it would be prudent to stay defensive with high allocations to bonds.