The S&P 500 closed the week ended April 15, 2016 at 2080.73, just a whisker away from the November 3, 2015 intraday high of 2116.48 and also its all-time high of 2134.28 at on May 21, 2015. In a little over two months, the S&P has rallied 15.0% from its recent low of 1810.10 set on February 11, erasing an 11.4% loss to start the year. It is now up 1.8% year-to-date.
There is a lot to like in this recent rally. Risk-on sectors, like energy, materials, industrials and most recently financials have led the market off the bottom. Risk-off sectors, like telecom, utilities, consumer staples and health care, which had provided leadership during this recent bout of uncertainty, have lagged. Although the economic picture remains mixed, trading action suggests that investors are more optimistic now about the outlook for the economy than they have been in nearly a year.
Although the market pushed higher last week to a new high for the year, upward momentum has slowed since the beginning of April. It is not surprising that the market would take a pause after so strong a run-up, but the slowing momentum probably also reflects uncertainty about the near-term outlook. Investors may have decided that the economic outlook is not as bad as they feared back in February, but it is not clear that a pick-up in growth is right around the corner, either.
On Monday, representatives from OPEC and Russia meet to discuss a production freeze. Iran, which is currently in the process of bringing its production back to pre-embargo highs, had said it will not attend. Several oil analysts, including Daniel Yergin from IHS, have said that the price of oil will likely plummet if the producers fail to reach an agreement. If it does, stocks will almost certainly follow closely behind.
Even without Iran, an agreement is still possible. Iran will probably commit to a freeze once it achieves its former production levels. By declining to participate in the talks, it is essentially saying that those producers who benefited during the embargo should agree to cut production back to their former levels. Saudi Arabia was undoubtedly a beneficiary, but it might not be keen to agree to a production cut that would benefit its rival. Assuming that a formal agreement will not be announced on Monday, the stock market may take the news in stride (with perhaps only a slight decline), if the negotiating parties demonstrate that progress has been made and that talks are continuing.
Besides Doha, the fundamental picture of the U.S. and global economies shows very little improvement (and perhaps some cause for concern). Although job growth has been solid, consumer confidence and industrial production have continued to soften.
The preliminary University of Michigan/Reuters Consumer Sentiment Survey declined 1.4% to 89.7 in April, its fourth consecutive monthly decline. The Survey’s Current Economic Conditions index was down only slightly, but the Index of Consumer Expectations fell 2.4% in April and was down 10.4% year-over-year. These declines have been driven by a weaker outlook for income growth and concerns that the pace of job creation will slow unless economic growth picks up.
Industrial production fell 0.6% in April, the sixth month-to-month drop in the past seven, according to the Federal Reserve. All three major components – manufacturing, mining and utilities, registered declines. The April production level was down 2.0% from a year-ago, the seventh consecutive month of year-over-year declines. The recent drop in the dollar, if sustained, could provide a boost to exports, but any gains could be fleeting, unless the economies of the importing countries – most specifically, the European Union – show improvement.
Operating earnings for S&P 500 companies are expected to be down 0.5% in the 2016 first quarter. Howard Silverblatt of S&P thinks that the bar has been set pretty low, so most companies should be able to beat estimates. Valuations are not excessive by historical standards, so the stock market’s near-term performance is likely to turn on managements’ guidance for the balance of the year.
All told, if the market is to rally beyond the 2015 peaks, it will probably need a catalyst – either from an agreement among major oil producers to freeze production or clear evidence of a pick-up in global growth. After such a strong two month advance, it would not be a surprise to see the market pause for a while as it awaits better news. Of course, that good news may not be forthcoming or other (geopolitical) events could change the outlook for the worse perhaps suddenly, so market risk remains high.
April 17, 2016
Stephen P. Percoco
Lark Research, Inc.
P.O. Box 1543
Linden, New Jersey 07036
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