Back Where We Started


by Ralph Cole, CFA Executive Vice President of Research

The S&P 500 rallied again this week and is back to even for the year. Our original outlook came under pressure from the first day of trading in 2016. We expected rates to be slightly higher for the year and within six weeks the U.S. 10-year Treasury yield had fallen from 2.30 percent to 1.66 percent. We expected stocks to have a modest return of between 5 to 8 percent this year and by February 11 the S&P 500 was down 9 percent. Finally, we thought we had seen the bottom in oil prices but the price of a barrel of oil promptly dropped to $26. We were then compelled as a company to step back and assess the situation.

As we always do, we went back to the fundamentals of the economy and the stock market. Our thesis for the year was that the American consumer was the pillar of the global economy and was on very solid footing. Consistent job growth (200,000+ per month), continued wage gains (up 2.5 percent year-over-year) and stronger home prices (up 5 percent year-over-year) led us to believe that the U.S. economy was expanding. That outlook has not changed at all.

Oil prices were reflecting general weakness in the global economy. We believed that oil demand would continue to grow in 2016, and the massive cut backs in capital spending by oil companies here in the U.S. would eventually lead to a drop in oil production. While timing is never certain, we believed equilibrium would be reached at some point during the coming summer. In the near term, lower oil prices continue to benefit consumers and businesses alike. Oil has since rebounded to $42 per barrel.

Data Dependent Fed

We believe the Fed has been very clear in its messaging over the past several months and their statements that their actions will be governed by the economic data as it is released. Clearly, global growth has been subdued year-to-date, and inflation remains contained. Thus, the economy is not in need of cooling. This environment has allowed the Fed to delay further rate increases until later this year.

Long-term interest rates still have not recovered from the drop earlier this year. While the 10-year Treasury rebounded from the lows set in February, it only yields just 1.87 percent today. We believe that rates will trend higher as the year moves on, but only gradually so.

Our Takeaways for the Week:

  • We are essentially back to where we started the year, with the S&P 500 slightly positive
  • The Fed is clearly not locked into any predetermined tightening cycle, and will wait for inflation or the economy to heat up before raising rates again