West coast port shutdowns, a strong U.S. dollar, lingering effects of a wild winter and both the ups and downs of low oil prices took their toll on the stock market this quarter.
On top of that, there was plenty of volatility with the Dow Jones swinging 1300 points from high to low. And many days of triple digit gains were mirrored the next day with triple digit losses.
Volatile Times
It’s a wonder the stock market closed the first three months of the year virtually unchanged.
The question is what is causing this wild range bound trading and, more importantly, what will break the market out of this pattern.
The two causes of this frenetic price action are uncertainty about when the US Federal Reserve will hike interest rates and the unexpectedly sharp drop in earnings expectations.
Sluggish Economy
The Fed has stated that they are dependent on stronger economic data before nudging rates higher. They do not want to be too hasty and risk a recession.
However the economy will not cooperate. Job growth is slow and manufacturing is not expanding.
In addition to interest rate uncertainty sudden drastic reductions in earnings estimates for many major US companies are curtailing the market advance.
Earnings Hit
As the year began the earnings of companies listed on the S&P 500 index were expected to grow 6 to 7% this year, according to my research.
With the advent of the strong dollar many large export dependent firms have been forced to cut sales and earnings estimates.
Some20% of S&P 500 companies have warned on earnings for the first quarter, with at least 49 companies citing the muscular dollar as the reason.
Oil Prices
Domestically the collapse of oil prices has curtailed capital expansion plans and reduced earnings, sales and profit margins for many companies.
As the depressed petroleum prices fail to rebound, the softness in the energy sector is beginning to spread into associated industries.
The resulting growth in earnings growth since the start of the year is now half of prior expectations.
Looked at in market terms prices have gotten ahead of themselves and a correction in either price or time may be necessary in my opinion.
Range Bound
By trading sideways for the last three months the market has begun a correction in terms of time. I believe this could continue as the volatility forces out impatient investors.
On the other hand I believe unanticipated news could cause a rapid price decline bringing valuations in line with the current reality of lower growth and lower profit margins.
Long-Term Bulls
Although we are amazed that the US market has held up this well in the face of current events we consider it a sign of great strength. We still believe the long term bull market in US stocks has some years to run.
However we think the advance will resume only after corporate earnings catch up with stock prices.
In the meantime we have reduced some US exposure and moved it to Europe and where current events are allowing those markets to prosper.
In addition we have recently added to our positions in China.
Photo Credit: Mike Mozart via Flickr Creative Commons
