Today the S&P 500 is making a new high for 2016 and is currently showing about a 1.5% gain for 2016. This is quite remarkable given the fact that the market got off to the worst start to a year on record, falling some 11.50% before finding a bottom. But as you can see from the chart above, even with this rally the S&P 500 is still trading right where it was back in Christmas 2014. So essentially the markets have made zero upside progress for the last 15 months.
So what happened? We discussed in prior posts how Oil was looking to be close to a bottom and the S&P 500 support zone around 1820. But what caused the sell off? The simple answer is; who knows. The stock market can suffer bouts of volatility whenever sentiment shifts quickly.
Of course the media has to make up a reason for everything. So you have no doubt heard the stories about China, Interest rates, global growth, oil, “insert scary prediction here”. While I can’t completely rule out any of these issues, the simpler answer probably lies in the fact that earnings growth was negative for 2015.
As you can see in the chart above, earnings for S&P 500 companies have been negative for the last three quarters and Q1 2016 is projected to be worse. Since buying stock is simply an investment in the future earnings potential of the companies you choose, there shouldn’t be a surprise when there is a period of zero stock market gains when overall corporate profits disappear. We combine this with the fact that the stock market is fairly to moderately overvalued depending on the metrics you use, and the result is a broader market with a higher tendency to be affected by any external shocks.
But the markets are always looking forward. So the big question now is has the worst been priced in already?
My belief is that the answer to this question is yes. Here is why. The two main drags on total corporate profits have been the commodities sector (specifically energy) and the strength of the US dollar.
On the energy side it has been the collapse of Oil prices that has caused earnings in the energy sector to crater. But lately Oil prices have stabilized and the energy sector has actually closed above its 200 day MA (above chart) for the first time in about 15 months. Stabilization would alleviate a lot of strain on overall corporate profit growth.
The second aspect is the strong US dollar. While a strong dollar is generally regarded as good for consumers, as it keeps inflation in check, it can be difficult on earnings for multinational corporations.
However lately the US dollar has stabilized below the $100 mark and looks to be headed back down to the bottom of this recent trading range between $100 and $93. This is another potential headwind that may be transitioning to a tailwind.
Looking forward the earnings projections seem to indicate a pickup in the 2nd half of 2016 and into 2017. Total earnings growth for 2016 is projected to be around, 2% but for 2017 the projections are up to about 13.5% right now. Keep in mind that these projections can be revised down at anytime, so nothing here is anything close to set in stone.
But assuming earnings growth can finally return in 2016 and 2017 and the US can continue to avoid a recession, there is a very good chance that the most hated bull market on record will continue to rage on.
In my opinion this is what I expect to happen. I expect to see the Dow trading at 20,000 before a major correction or bear market takes place. But nothing is certain or guaranteed, so having a well defined investment plan in place, that has been stress tested, is better than trying to time or anticipate the intermediate term price fluctuations.