Financial Markets: 4th Quarter 2015 Market Commentary

3rd Quarter Review

Financial markets went on a roller coaster ride in the third quarter and so did people’s emotions.   The S&P 500 had it’s worst quarterly return since  the 3rd quarter of 2011.  Domestic and International stocks ended the quarter down significantly with emerging markets losing over 15%.  Bond returns ended the quarter positive in a flight to safety.  In this issue of Allgen’s quarterly market commentary, we will discuss concerns around the global economy, market sentiment, and cyclicality.

Global Economy

International and Emerging markets took a major hit last quarter and are down significantly for the year.  Various economists have been lowering their outlook for growth for the global economy.  The Organization for Economic Cooperation and Development (OECD) cut its 2015 forecast from 3.1% to 3% and its 2016 forecast from 3.8% to 3.6%.  They expect Chinese growth to slow to 6.7% this year and 6.5% next year after 7.4% in 2014.  On the other hand, all the major world economic organizations are predicting stronger growth in 2016 than in 2014 and 2015.  While the slowdown in China and most emerging markets has dragged down the global economy recently, there are some signs that the slowing economy is already priced into the markets.  In fact, from a charting standpoint there are signs that point to a bounce.  It is important to look at oil and commodities as a gauge to the health of the emerging markets and the global economy. Oil is a huge revenue source for a lot of emerging markets. While oil has dropped dramatically over the last year, it is showing signs of at least a short to intermediate term bounce (as seen in the chart above).  After going as low as $37 per barrel, oil has recently bounced and even broken above some short-term resistance at $46.  It’s also had a positive divergence as shown in the chart above (A bullish sign from a charting standpoint).  Other charts of emerging markets are showing similar positive patterns that indicate a high likelihood of a bounce.

Market Sentiment

The recent drop in the stock market caused a significant level of fear; we would venture to say irrational levels of fear.  The S&P 500 dropped a little over 12% from its highs in July.  But fear (as represented by the Volatility Index (VIX)) reached its highest level since the market low in March of 2009 after the S&P 500 had dropped over 57% from its peak to trough  (Chart on left). Historically high levels of fear during market drops have been good times to buy.  See the yellow vertical lines in the chart which represent market drops with high levels of fear.  Each one represented an excellent buying opportunity.  Other sentiment measures like the AAII Sentiment Survey also showed excessive levels of bearishness.

Cyclicality

There are a few cycles that favor a rebound in the markets going into the end of the year.  We are in the 3rd year of the
presidential cycle (see chart below).  Since 1940, every 3rd year of the presidential cycle has been positive in the S&P500.  Also, since 1896 for the 3rd year of a second term the market has been positive 90% of the time.  We are also in the 5th year of the decennial cycle and since 1890, every 5th year of the decennial cycle has been positive. Finally, we are ending the weakest period of the year which is August – October, while we are about to enter the strongest part of the year November – January.

Going Forward

The global economy has shown signs of weakening, which causes some economists to lower their expectations for future growth.  Even so, major world economic organizations are predicting stronger growth in 2016 than in 2014 and 2015.  Also, some charts of oil and emerging markets have hinted to a short-term rebound.  The last quarter was volatile and caused a lot of fear.  Historically high levels of fear tend to be great times to invest.  We encourage clients to use a dollar cost averaging approach of investing an equal dollar amount on a monthly basis.  If markets go down you buy more shares and as prices go up you buy fewer shares giving you a disciplined way of investing in good and bad times.  We are cautiously optimistic that going into the end of the year the markets will bounce.  In the recent quarter, we used the strength in bonds to sell at higher prices and buy in stocks that have recently dipped.  We constantly monitor market factors and adjust accordingly as our proactive money management style seeks to take advantage of pricing anomalies. We continue to manage risk first in all of our investments while seeking to outpace our clients’ respective benchmark over the long-term net of our fees.