May 2016 Monthly Outlook

by on May 8, 2016 Categories: monthly outlook, stock market, economy, investments

Economic Commentary:

Recent data showed that the U.S. economy struggled mightily in the first quarter, the third time in as many years that business wilted in the opening quarter. The key factors in this all too familiar early year trend (which held GDP growth to just 0.5% in Q1) were a deceleration in consumer spending, lower export demand, and declining business investment (with this latter setback a consequence of the difficult earnings outlook among many corporations). The recent economic lethargy clearly had an effect on the Federal Reserve,with the Fed’s latest FOMC meeting (which ended on April 27th) concluding with no rise in interest rates.The Conference Board Leading Economic Index® (LEI) for the US increased 0.2% in March to 123.4. “With the March gain, the US LEI’s six-month growth rate improved slightly but still points to slow, although not slowing, growth in the coming quarters,” said Ataman Ozyildirim, Director of Business Cycles and Growth Research at The Conference Board. “Rebounding stock prices were offset by a decline in housing permits, but nonetheless there were widespread gains among the leading indicators. Financial conditions, as well as expected improvements in manufacturing, should support a modest growth environment in 2016.” 

Indicators point to the US economy continuing its slow growth (~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:

The stock market rally that started in February, and gained steam in March, started to fade as US large cap stocks increased 0.39% for the month, bringing the return in the past 12 months to a mere 1.11%. The energy sector was the best performing sector of the US market in April as it increased 9.06% with the price of oil rebounding to above $40/barrel. It appears oil has found its bottom but energy stocks remain unattractive at these levels because most of the energy exploration and production companies need oil prices above $50 just to break even. The technology sector was the worst performing sector in April as it decreased 5.03% because of disappointing earnings reports. Bonds increased 0.26% in April, bringing their total return the past 12 month to 2.56%.

With this market rally stocks are now trading at very high historical valuations, especially relative to the slow to negative earnings growth of the market. Therefore, we remain very cautious on stocks as they could be set for a fall unless earnings pick up within the next year.

Evidence of market history strongly suggests we are currently in the relatively early stages of a full-scale bear market, therefore it would be prudent to invest for downside protection and stay defensive with higher allocations to bonds and the consumer staples sector.