Economic and Investment Update: First Quarter 2016

It doesn’t take a sophisticated investor to know that this past quarter has been a roller coaster ride for the stock market. US stocks are down a bit over 4% over the past 3 months (6% over the past year), but this is up from their 3-month low of over 10%. Non-US stocks from developed economies (Europe/Japan) and emerging markets have shown even more volatility. Developed market stocks are down 7% over the past 3 months (15% over the past year), while emerging markets stocks are down 2.2% (21% over the past year.) Much of the investor news has centered around two issues that are interrelated: China’s economy and the implosion of the world oil market.

At first blush, China’s economy should not be that big a factor in influencing US stock prices. US exports to China after all, account for only 7% of total US exports; however, China has had a growing influence on world trade, including the US, over the past twenty years. The persistent slowing of their large economy has had an oversized negative psychological impact on the markets over the past year.

Another related factor to this negative market psychology is the huge downdraft in oil prices. Over the past 18 months the price of a barrel of oil has declined from $100 to just under $40 a barrel today. Again, at first glance, a decline in oil prices should be a good thing for equities: as gas prices go down, consumers have more dollars to spend, which in turn leads to greater consumption etc. etc.; however, if consumers don’t spend but save those extra dollars, which in large part is what the American consumer has been doing, then at least in the short run, the positive economic effect of low-priced oil is lost. Moreover, for US oil suppliers, the oil market implosion has meant the loss of revenues and profits, resulting in declining domestic investment and jobs.

How are China’s woes and the world oil market related? Both have become a proxy for measuring the short-term outlook for world economic growth. As the story goes, if China’s economy goes from hot to lukewarm, then this negatively dents world trade and growth, particularly in Asia, where China’s largest trading partners are. Their declining economy results in reduced demand for oil, putting downward pressure on the price of oil. The reduced demand for oil, although a somewhat imperfect measure for world economic growth, would then continue to put downward pressure on world stock prices.
How long this short-term fixation on oil and China will last is anyone’s guess. What we do know is that the underlying US economic fundamentals: slow but steady growth (2 to 2.5% annualized), low inflation, decreasing unemployment and underemployment accompanied by increasing wages, are likely to continue at least for the next year. With stocks fairly valued, that means the individual investor should stay the course while these temporary external factors affecting the market get sorted out.

by Barry Jamieson, MA


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