Market Update Q2 2015

Market Update Q2 2015

7With the second quarter well under way, investors have started to get a feel for what the year’s returns will look like.  So far, 2015 has seen first quarter growth which reflects a more typical of average returns with no ballooning uptrends solidifying so far in Q2.  As of the time of this writing, the market [1]posted gains of 1.9%, that’s an annualized return of 5.2%.   Compared with the augmented returns of prior years, an annualized rate of 5.2% feels somewhat lacking.  It seems the tenet for markets this year has been 1 or 2 attractive up days followed by a week of moderate losses ultimately resulting in slight but steady gains.  As a firm, our philosophy throughout 2015 has been and will continue to be a focus on the long term; avoiding the volatility of daily market swings and focusing on quarter to quarter growth.  While the core economy in the U.S. remains fundamentally solid, there are a few international downward pressures reining in domestic growth.

At the core of all the negative pressure on markets has been the downtrend in oil.  Although oil has rebounded 42% from its 6 year low (as it now sits at $59.72), it is still trading considerably lower than its one year high of $107.73.

Nymex

Much of the rebound has so far been attributed to investors trying to predict a bottom to the freefall along with an implied expectation that producers would have to begin to curve supply at some point to maintain their profit margins.  However, to sustain the rally long-term, oil will require an increase in demand or a decrease in supply, one that seems all too unlikely given OPEC’s current tone.  According to the U.S. energy administration, global demand will grow only marginally into 2016 when compared to the growth in demand enjoyed during 2010 after oil’s last major price drop.  In fact, the U.S.E.A has predicted demand for oil will grow at just 1.3 million barrels year on year through 2015 compared with the 2.9 million barrel jump in 2010.  Much of the growth experienced during the 2010 recovery was due to China’s insatiable appetite for energy which has waned significantly as of late.  Domestically, the demand picture isn’t any better as the U.S. is expected to consume just 19.44 million barrels daily, a level less than 2008.  Having to rely on growth domestically to bolster production and GDP has proven nearly fruitless as global forex markets have put even further strain on U.S production.

As mentioned above, the first quarter of the year experienced less than stellar growth.  Although lower oil prices should have bolstered the profit margins of businesses and households alike, the decreased profit margins created by lower oil prices led oil producers to lay off a larger than expected number employees as evidenced in the April jobs report.  Moreover, the Federal Reserve continues to herald a rise in interest rates to come ‘when economic conditions allow’.  This statement has acted as somewhat of a growth-preventive policy in that market reactions to good news have been overly cautious of late so as not to incentivize the Fed to raise rates any sooner than absolutely necessary.  With conditions, or at the very least, speculation of an interest rate increase domestically along with the implementation of the quantitative easing program in Europe, conditions are stacked against companies exporting goods abroad.

forex

With a presumed fiscal tightening in the U.S. and quantitative easing in Europe, the euro/dollar exchange rate has begun to move toward parity as seen in the graph above.  Thus, domestic companies’ products are being viewed as increasingly expensive; while it becomes ever cheaper for the U.S. consumer (and companies) to import goods from abroad.  Ultimately, this reduces net exports, overall GDP and securities markets domestically and it will continue to promote languid growth.

Given the bearish pressures elucidated in this update, it is important to note that we maintain our current market[2] target for the year of 6% to 8%.  Although domestically, markets face several headwinds, the magnitude and scope is limited.  With oil, there is a finite amount of time that all producers can continue to keep supply elevated and prices depressed; assuming their current margin cannot sustain their business model.  Moreover, the exchange rate shock is an adjustment that we feel can and will be priced in over the remainder of the next quarter as companies will be better able to anticipate a move toward parity with the euro.  The one remaining uncertainty to markets lies with the Federal Reserve.  We feel that any rate increase, if it were to happen this year, will not occur until December or the first quarter of 2016.  Although a rate increase will undoubtedly curb investment, it is ultimately something that we feel the Fed will introduce when the economy is truly ready to support such a change and thus feel markets will trend upwards for the year.

[1] The S&P500 index is used as a proxy in calculating market returns

[2] The S&P500 index is used as a proxy in calculating market returns