Oh, somewhere in this favored land the sun is shining bright; the band is playing somewhere, and somewhere hearts are light, and somewhere men are laughing, and somewhere children shout; but there is no joy in Mudville - mighty Casey has struck out.
Stock market rally fizzles into quarter end
By mid-September, US stocks recovered half the losses sustained in August, but the rally did not hold, leaving the S&P 500 just above the YTD low set August 25th, and barely above the low set last October. Stock prices fell 11.7% from the May 2015 all time high, and declined 6.4% in Q3 2015. Prices recovered smartly the first two days of October despite a poor jobs report.
How concerned should we be? For the first 7 months of 2015, stocks traded in an exceptionally tight range as the Greek debt crisis played out. Just as that concern resolved, a new concern - China currency devaluation! - seized the imagination of investors. Oddly the modest 3% decline in the renminbi in August upset investors more than the 20% decline in the Euro since May 2014. Odd because US exports to China represent 7% of total American exports, and 1% of GDP, while exports to the Eurozone represent 12% of exports The Euro devaluation has a far greater negative effect on US corporate revenues and earnings.
A few of our clients have inquired whether the US stock markets failure to progress over the last year is an early warning of another bear market. William Smead at Smead Capital recently wrote "What's the Market's Biggest Risk" and detailed whether we're setting up for another bear market to match or exceed the 5 biggestbear market of the last 100 years.
Smead agrees with our analysis that the factors that create bear markets:
- Overvalued stock or real estate prices
- Over-leveraged banks, investors and consumers
- Sharply falling corporate earnings
- Sharply rising interest rates
simply are not present. Stocks are slightly undervalued, interest rates are low and will rise at a moderated pace over the next two years. Leverage is low among banks, corporations and consumers. The US economy looks brightest among the major industrialized nations, yet the Fed can move slowly on raising rates as inflation is virtually zero.
Current conditions remind us of the 14.3% correction which occurred 4 years ago in Q3 2011. The issue back then was concerns about whether European countries, such as Greece, Italy, Spain and Portugal could pay back debt. It's worth noting that US stocks rallied 24.5% over the next two quarters, and 69.7% over the next 4 years. In stocks, "it's always something," but the investors who look past short term worries are handsomely rewarded over longer time frames.
The biggest weakness in the US economic outlook is the US jobs market. The most recent 5.1% unemployment rate masks a 9-10% "stealth" unemployment rate given low labor market participation. On Friday the Labor department announced just 151K jobs created, which is 100K less than the monthly average of jobs created in 2014. To create "true" full employment, the US needs to add 300K jobs per month, 200K just to keep up with demography, and another 100K to bring "discouraged" workers back into the labor force.
A recent survey of stock market analysts shows an average expectation that the S&P 500 will finish 2015 with an average gain of 4.4%. Our forecast is a little higher at 6%.
US Presidential Election update
Among the "biblical plague of Republican candidates," Perry and Walker have already stepped down, and we expect Paul, Jindal, Santorum, Graham and Pataki to be out by year end. Trump, Carson, and Fiorina, the "un-politicians" are leading on the Republican side, though Trump and Carson's poll numbers are down after the most recent debate. All three are deeply flawed, yet the primary base is so enraged by "politics as usual" that each has traction. Jeb Bush, who led the polls through July 2015, is now in 5th place and at risk of disappearing completely.
On the Democratic side, Clinton's inability to put the e-mail "scandal" behind her created an opening for Joe Biden to jump in. Aside from gender, both veterans of the Obama administratiion are pretty much identical on policy positions. Clinton's decline from 60 to 40% in the polls is driven almost entirely by Biden syphoning off Clinton supporters. Biden faces a rapidly closing window on whether to run. It's already unlikely he would join the first Democratic debate on October 13th. State primary filing deadlines expire as early as November 6th. Biden has no campaign infrastructure in place, while Clinton and even Sanders already have national organizations. Our money remains on Clinton as the eventual nominee, but the selection process is far more competitive than we imagined 6 months ago.
We wondered whether the increasingly negative and pessimistic rantings of the major candidates would negatively affect average Americans. So far, no. The latest Consumer Confidence reading is at the highest level since September 2007. We conclude that most Americans beyond the "chattering classes" are simply not paying attention, and won't pay attention until summer 2016.