January 2016 Monthly Commentary
Market volatility erupted in the first few trading days of the New Year and continued into early February. By the third week of January, the S&P 500 was down by nearly 10% before reversing course and erasing about half of those losses. Reacting to the panic, investors sold risky assets and bought Treasury notes en masse, resulting in a 35 basis point rally in the 10-year note for the month. The severity of the selling prompted market bears to warn that “as goes January, so goes the year.” To test that thesis, we studied the performance of the S&P 500 in every January since 1990. Of those 27 observations, 12 January’s were negative, and of those twelve losing months, only five preceded a losing year. So a losing January had a mere .185 batting average at foretelling full year performance. The worst January performance was in 2009, following the financial crisis. The S&P 500 fell index fell 8.5% that month, then reversed course and registered a full year return in excess of 30%. Of course, that’s not to suggest that this year will be a repeat of 2009. At that time, the market was rallying back from a vicious selloff that took approximately 50% off of the value the S&P 500 index, the Fed was in the early stages of quantitative easing, and the widespread use of corporate buybacks was just getting started. However, as we’ve discussed on a number of occasions, there are solid fundamentals in place that should be supportive of the markets and could quite possibly drive stock prices back to previous highs. However, if investors panic, the selloff could have further to go.
In many ways investors are behaving exactly as expected given the conclusion of seven years of Federal Reserve “hand-holding.” Ironically, with a little over a month since the rate hike, some forecasters are calling for a rate cut and resumption of quantitative easing later this year. Despite that, the money markets are functioning in a remarkably smooth fashion. Fed funds, 3-month LIBOR and overnight General Collateral repo, three measures of a well functioning money market have all been rock solid and steady since the rate hike. Similarly, the massive reverse repo program the Fed launched to ensure they would be able to sob up the excess liquidity in the system has been little used and is nowhere near its mandate cap.
Then why the suddenly bearish stock market performance? Seemingly, the best answer is that traders are speculating that a combination of falling oil prices and higher interest rates will tip the U.S. economy into recession. Supporting that theory is the slowdown in manufacturing that’s been going on since last summer. To be sure, multinational earnings have been impacted by the strong dollar. While that’s certainly a drag on profitability, we’re seeing indications that the move has run its course and the currency market may be on the verge of stabilizing. What’s gone unnoticed is that with those earnings releases, in many cases management has announced further expansion of corporate stock buy backs. On a trailing twelve month basis through Q3 2015, corporations bought back $556 billion of stock. With some stocks trading 10% to 20% below their recent peaks, CEO’s will be more incentivized than ever to issue corporate debt and buy back the shares. As we’ve discussed on numerous occasions, doing so improves the perceived performance of the company, enabling the CEO to point to a rising stock price and rising earnings per share, and pay herself handsomely for a job well done.