In recent weeks global stock market volatility has continued, this time to the upside. After one of the worst starts to a calendar year in history, global stock indexes have almost recovered this year’s losses — though still lower than the highs reached in May of 2015. This recent market strength may serve as a relief to investors, but as much as prices have changed recently, economic data points and market internals have not…yet.

The market turmoil that began in August of last summer was based on slowing economic growth — particularly in China — coupled with a Federal Reserve adamant about raising interest rates. These forces increased the risk of a stalling economy or recession and the possibility of a prolonged decline in stock prices. The dovish commentary offered yesterday by the Fed reiterated concern about how fragile the global economy currently is. Unfortunately these weak global economic factors have not changed for the better, though stock prices have in the short term. Investors should be careful about embracing this recent strength as a sign that “we are out of the woods” and be reminded that this economic expansion is in its eighth year — old by many measures.

Though we would prefer that stock market fundamentals were improving, the fact is that they are not. The latest decline in stocks puts pressure on sectors that were previously holding up — such as financials. We can now count seven out of ten sectors that are in established downtrends. The only three that remain in uptrends are utilities, healthcare and consumer staples — areas where your portfolio is significantly overweighted.

The recent market strength is most focused on the areas that were hit hardest coming into the year, namely, oil, commodities and industrial stocks. Our research suggests that these stocks have rebounded significantly for one of two reasons: 1) there were so many investors that had sold these stocks short that they have been scrambling to buy them back — hence driving the prices up in the short term; or 2) there is a significant underlying change occurring in the economy that isn’t apparent in the data and that may lead to a stronger economy ahead. At this point we doubt the latter of these possibilities is likely as the market continues to be expensive and extremely overbought. However, should the data points change, we stand prepared to seize the opportunity for profits and make your portfolio less defensive. The next correction in stock prices — which is imminent — should tell us more about this situation.

In the meantime, we continue to be more “safe than sorry” and mitigate the risks of a further decline in stock prices through your portfolio’s asset allocation, sector management and the use of carefully placed stop loss orders.

We hope you find this update helpful. If you have experienced any change in your financial situation or would like to discuss your portfolio, please let us know.

Sincerely,

Your Team at Main Street Research