March madness is here, with the always exciting college basketball tournament in full speed. The month of March has been a thriller from the get-go on Wall Street. It’s been a wild year. From the deep lows in January, which brought a fierce immediate 11% decline, both the DOW and S&P roared back, erasing the losses, and are in positive territory for the year. It’s been quite a ride. Since 1945, there have only been 4 times where the stock market experienced a 10% decline and finished the year positive. It is extremely early in the year, but 2016 is set up to be one for the ages. I’m not just talking about the colorful Presidential election.
The Fed injected more fuel to the rally this week, when they stated their rate hike campaign will be slower than previously outlined, and that global issues are influencing their outlook. The Fed has been in a tough spot because the US is in much better shape than the rest of the world. It can no longer operate in isolation. The Fed’s domestic dual mandate of price stability and full employment predates globalization. The Fed has effectively become the global central bank, and its policies, which impact interest rates and the Dollar, send waves through the global system. The Dollar has weakened and Oil has surged. The world is so connected today, for better or for worse.
Unfortunately, we don’t think the correction is quite over yet. The Bond Market is not confirming this rally and interest rates are sliding again. Money has been rotating back into bonds as this rally extended. Rising rates would actually be bullish at this stage. It would suggest demand is real and growth is accelerating. Growth is largely absent overseas and the US is stuck in slow growth mode. It’s still growth, but there’s no acceleration that we can see. The 2 keys have been the Dollar and crude. Oil prices have jumped over 60% in a month, clearing $40 for the first time this year. That has gone a long way to help soothe the pain in the credit markets. But that will only last if oil prices hold these levels and continue to rise. Conversely, the Dollar has fallen, which has been a driver of commodity prices and has been a stimulant for US exports. That’s good for the US. But the weak Dollar is driving the Euro and the Yen and other foreign currencies higher which is sabotaging foreign central bank strategy. The global economy is still struggling. And that’s a big reason why we think this rally will fizzle soon. The election isn’t helping either.
The Stock Market is no longer cheap. At the break-even point of 2043 (which coincides with DOW 17,400), the S&P 500 is trading at 17X this year’s expected earnings. That’s on the expensive side. And those earnings are not growing much. In fact, the estimates could even prove to be a little high. With so many unknowns economically, politically and geopolitically heading into the Summer, it’s hard to see the stock market have a material breakout from current levels. It doesn’t mean it has to crash and take out the lows from January and February. The stock market just feels heavy, and the risk/reward balance at this point isn’t as compelling to us after the rally. Traditional growth areas like Biotech and Tech aren’t leading anymore. In fact, despite the DOW and S&P gains, the Tech and Biotech heavy Nasdaq index is still down 5% on the year. We would also like to see Financials breaking out and leading. That would be bullish. It’s still not happening. We played the rally. We are now taking money off. We expect the choppy price action of 2016 to continue, and still look for things to clear up and stabilize in the second half of the year.
We still think the Bull Market which began in 2009 is alive. We just see this correction taking longer. This is the 3rd longest Bull Market in history, so naturally, corrections should be longer too. So we plan to continue to play the risk/reward probabilities with our investment strategies. We bought the weakness and removed our hedges in January and February, and are selling some strength in March. With so many unresolved problems out there, we want to preserve these gains. This has been our consistent approach to the stock picker’s market.
We try to be as clear and candid as possible with our approach. As a reminder, this is what we wrote in mid January, at the lows of the year:
The Wednesday reversal might not have been capitulation, but it certainly felt like it was in the neighborhood. It was comforting to see a continuation of strength to close out the week. It’s key to see if it can build off the positive momentum. Giving it up won’t be good. We believe this is likely an oversold bounce we’re getting, not a sustainable rally just yet. We have reduced some of our Market hedges during the decline. This swift and violent selloff has gone a long way to correct the excesses in our minds. Though we expect this turbulence to continue a while longer, we are seeing some really attractive buying opportunities. To be clear, we don’t see the end of this correction quite yet. We are still in defense mode, but our buy list is growing. Stay tuned.
This has been an impressive rally from the lows. There was a lot of panic earlier in the year. The panic has abated. But the issues that caused them are still around. We work tenaciously on your behalf. We like to buy low and sell high. It’s never easy. Price matters.
Have a nice weekend. We’ll be back, dark and early on Monday.