Since last summer, global economic growth, led by China, has slowed significantly. This, as you are well aware, has caused significant volatility in equity markets both here and abroad. Though stocks have rallied recently, they remain below the levels reached at their peak. A greater concern among investors is that the long uptrend in stock prices that began in 2009 — and this bull market — appears to have stalled and, in some stock sectors, we have seen significant downtrends. This raises questions about the future direction of stock prices over the next few quarters. As Janet Yellen of The Federal Reserve stated earlier this week, the answer to that question will be dependent mostly on economic data — the very issue that started this difficult change in market behavior last summer.
We could not be more supportive of Janet Yellen. She is intelligent, an experienced Fed board member, and a great communicator. The main theme of her message was focused on the fragile nature of today’s global economy and the risks of a downturn should current headwinds continue. In addition, Ms. Yellen clarified that the Federal Reserve would moderate the pace of interest rate increases in light of the less than stellar economic data. As you may know, rising interest rates effectively slow economic growth — which at this point could be detrimental to this already fragile economy. In this regard, we believe that Ms. Yellen is “spot on.”
In her outlook for future quarters, Ms. Yellen speculated that current economic headwinds — including China, oil prices and corporate earnings deterioration, among others — may dissipate allowing the global economy to gain strength, which would be supportive of higher stock prices. Though that outcome would be welcome to our team, we question its viability and we know it is not a sure thing even if Janet Yellen said it! The pace of each of these headwinds has yet to slow. Data from China has not surprised on the upside, oil’s recent strength has faltered, and recent corporate earnings reports were revised down 8.7%, the worst such downward revision since 2008-2009, the year of the last recession.
As we have discussed recently, this economic expansion is now in its eighth year and recessions historically come along every seven to nine years. Recessions are a normal part of the business cycle and are defined as more than two quarters of negative economic growth — not far from the recent 1% annual growth reported for the US economy. Should the economy enter a recessionary phase, it would likely be mild by historical standards and would be over within a few quarters. However, the current level of stock prices for most companies is too high (especially given the recent rally) and would need to go lower to adjust to a lower profit growth environment. However, some companies and their stock prices would be less affected by a recession, namely consumer staples, healthcare and utility companies, areas where your portfolio is currently over-weighted. Most of these stocks held up well through all of the recent volatility and also did fine during the recession of 2008-09.
Even though we have Janet Yellen at the helm, our own decades of experience and some of the best research on Wall Street, we are still dealing with the unknown. Therefore, we stand prepared to become more growth oriented should economic data points and financial markets get on better footing — we look forward to that change! In the event that the economy gets worse before it gets better, we will continue to manage risk through your portfolio’s asset allocation, sector management and the use of carefully placed stop loss orders.
We hope you find this quarterly update helpful. If you have experienced any significant change in your financial situation, or would like to discuss your portfolio, please let us know. Thanks again from all of us for your vote of confidence during this volatile period.
Sincerely,
Your Team at Main Street Research