Once again, the precipitous decline in the value of the Chinese stock market has spilled over to the broader global financial markets. The value of the Shanghai Index declined almost 15% since the beginning of the year, or at least the beginning of our year. China’s social and economic life is geared around the lunar New Year, which will be celebrated on February 8, 2016. The New Year makes a big difference in China, both psychologically and in real economic activity. Workers in China have seven days off and many travel home to visit family. In one week, years of migration from rural areas to cities is reversed, at least temporarily.
Investors are revisiting issues last considered in August — primarily, the connection between China’s stock market and economy and the broader implications for the global economy. Our basic views on China remain consistent. China’s short-lived stock market bubble burst, but there is little connection between the market and the economy. China is undergoing a painful, but necessary, rebalancing of its economy away from strong government-led infrastructure and manufacturing-based development and toward a more consumer-led and service-based activity. We believe that China’s government still has the resources to smooth this transition. However, new risks are appearing. Many of China’s recent problems appear to be self-inflicted, caused by poorly designed or communicated government policies. China has taken steps to liberalize aspects of its financial markets without the intended result. We will detail some of these new policies and factors and how they may impact China, in addition to the rest of the world.
A number of key U.S. and global economic reports are due out this week (January 4 – 8, 2016), as investors return from the holiday break and refocus on many of the same issues that bedeviled the market in 2015, including the price of oil and the signal it is sending about the health of the global economy. As markets look ahead to the start of fourth quarter 2015 earnings reporting season, which won’t kick into high gear until late January 2016, the price of oil and its impact on business capital spending and manufacturing remain as key concerns.
The reports out this week on the manufacturing sector include:
- Markit Purchasing Managers’ Index (PMI) for manufacturing for December 2015, which was released as this commentary was being published
- Institute of Supply Management’s (ISM) Report on Business Manufacturing Index for December 2015, which was also released as this commentary was being published
- November 2015 factory shipments and orders report
- December 2015 employment report, and specifically the job count in the manufacturing sector
Our analysis of 2016 “surprises” discusses lower-probability, but high-impact events that may unfold over the course of 2016. While no one can predict the future, the surest way to build a surprise-resistant investment plan is to take the time to consider all potential outcomes. Thinking through all possibilities, even those that may not be the most probable, can help investors understand how different scenarios may play out, and allow them to see the warning signs that may indicate a shift is ahead. With this in mind, we explore potential surprises that could impact markets in 2016…
The long anticipated sustained rise in interest rates has failed to materialize over the past several years. Is 2016 the year? Market-based estimates of future interest rates are low, but a pickup in inflation, better economic data, or both could easily lift those expectations and bond yields along with them….
This week’s commentary features content from LPL Research’s Outlook 2016: Embrace the Routine. Gains in 2016 may require tolerance for volatility. Stocks historically have offered a tradeoff of higher return for higher risk, the gain of more upside than high-quality bonds versus the pain of market volatility and losses. For the last few years, U.S. stock markets provided below-average pain, while still providing strong returns. Between October 2011 and July 2015, the S&P 500 Index went nearly four years without a “correction” of more than 10%, while climbing an average of 20% a year. Although we expect average returns for stocks in 2016, the path to reach them will be anything but routine. LPL Research expects stocks to produce mid-singledigit returns for the S&P 500, consistent with historical mid-to-late economic cycle performance, driven by mid- to high-single-digit earnings and a largely stable price-to-earnings ratio (PE). This return to a more normal market may mean more volatility, challenging investors’ ability to stay focused on their goals.
HOW IS 2016 SHAPING UP?
In 2016, we expect the macroeconomic environment to be molded by a midto-late cycle U.S. economy, modest inflation, and the start of a Federal Reserve (Fed) rate hike campaign. If the U.S. does not enter recession in a given year, the probability of an S&P 500 gain is 82%, based on historical data from 1950 to present. Heading into 2016, there have been scant signs of excesses in the U.S…
When you think of a routine, what is the first thing that comes to mind? Some may think, it’s the mundane, the small steps and processes you follow to accomplish all your tasks for the day. But routine is more than that. It’s about forming good habits, feeling prepared. And perhaps the best part of a routine is the comfort that comes from knowing what to expect. For investors, the definition of a good routine would be knowing what to expect from the markets.
Is there such thing as a routine year for markets? Over the last 50 years, the S&P 500 Index grew at an average of about 10% a year, but its return was between 0% and 20% in any single year less than half the time. We haven’t witnessed a price return of 6 – 11%, a range that might be considered typical for markets, since 1992, over 20 years. And even when there was a year in the routine 10 – 20% range, there were other things going on in the markets that made the year feel anything but routine. Yields may have been extraordinarily low, or extraordinarily high. Commodities were booming, or collapsing. There really is no such thing as a routine year for markets. However, your financial advisor and LPL Research’s Outlook 2016 can help you prepare for what we may see in the year ahead.
The day after Thanksgiving, also known as Black Friday, seems to receive more media hype each year, as it is the unofficial kick off of the holiday season. Markets also pay attention, as Black Friday has historically been an early indicator of consumer demand during the important holiday shopping season. But Black Friday sales estimates have fallen for the past two years, leading to the question, is the weekend after Thanksgiving as impactful as it was in the past? And, should investors be worried?
The Black Friday weekend has been a draw for consumers since the 1950s, but media coverage has picked up steam in recent years, with people braving cold weather, long lines, and short tempers to find the best deals. Contrary to popular headlines discussing the frenzied madness, sales estimates for the Black Friday weekend have actually decreased over the past couple of years. Does this mean that Black Friday shopping is becoming less relevant for consumers?
One driver of lower Black Friday sales relative to history is the wider usage of internet retailers. Online sales have increased over the past decade, so much so that they earned their own discount day — Cyber Monday. This term was originally coined in 2005 when everyone returned to work the Monday after Thanksgiving. Corporate networks used to have much higher speeds than the typical home, and employees still in the Black Friday mindset would go into work and do their holiday shopping online. With broadband internet access widely available now, online sales are no longer dependent on Cyber Monday, though the propensity for online retailers to offer special deals on the day means it continues to be relevant.
Despite lowered expectations, some high-profile “misses” have occurred on global gross domestic product (GDP) readings for Q3 2015, causing concern for some market participants. The United States (23% of global GDP), China (13%), the United Kingdom (4%), South Korea (2%), Indonesia (1%), and Singapore (less than 1%) have reported Q3 gross domestic product (GDP). Together, those countries account for nearly 45% of global GDP. Third quarter 2015 GDP in three of the six nations beat or matched consensus expectations (China, South Korea, and Singapore), and three of the six countries reported results that either were in-line with or accelerated versus the prior period (South Korea, Indonesia, and Singapore). As a reminder, two-thirds of Q2 GDP reports beat or met expectations, while a similar percentage accelerated from Q1 2015 results; thus, the Q3 GDP results to date are lagging, relative to even lowered expectations. Still, with 55% of global GDP yet to report Q3 2015 results, the reporting season still has not reached the halfway point.
This week (November 8 – 15, 2015), another six countries are scheduled to report Q3 GDP, including the Eurozone (24% of global GDP), Japan (6%), Russia (2%), Poland (1%), Thailand (less than 1%), and Malaysia (less than 1%). Together, these nations — a nice mix of both developed (Eurozone and Japan) and emerging markets (Russia, Thailand, Poland, and Malaysia) — account for 34% of global GDP. Therefore, by the end of the week, countries representing nearly 80% of global GDP will have reported Q3 data. Over the second half of November and the first half of December 2015, another 15 – 20% of global GDP will report on Q3, including (ranked in order of size of economy) Brazil, India, Canada, Australia, Mexico, and Turkey, along with Switzerland, Sweden, Argentina, Norway, South Africa, Denmark, and the Philippines, again providing further insight into both developed and emerging market economies in the third quarter.
Profit margins may continue to defy the skeptics and remain elevated. The primary drivers of robust corporate profit margins remain largely intact, including limited wage pressure, corporate efficiency, and low input costs, and support our view that earnings growth may be poised to accelerate through year-end and into 2016. Despite a lack of revenue growth, the operating margin for the S&P 500 remains near multi-decade highs; we expect corporate America to continue to defy the skeptics and potentially generate strong profit margins over the next several quarters and likely beyond.
The S&P 500’s operating margin remains near multi-decade highs despite several challenges. The business cycle is now more than six years old, a bit on the long side relative to history, which has led some to predict profit margin contraction. The economy has produced several years of steady job growth and the unemployment rate (5.1% in September 2015) is low, which would normally bring some upward pressure on wages and hurt margins. To an extent, margins are mean reverting, so they tend to head back to their long-term average after periods of strength such as we have experienced. Interest rates have bottomed, perhaps suggesting that borrowing costs may be poised to move higher. Yet, despite all of these reasonable arguments for margins to contract, the S&P 500’s operating margin remains near multi-decade highs. We see little reason to expect much, if any, margin contraction for at least the next several quarters. We expect strong profitability to support earnings growth acceleration in late 2015 and early 2016 and provide a favorable backdrop for the stock market. The primary drivers of robust corporate profit margins remain largely intact, supporting our view that earnings growth may be poised to accelerate through year-end and into 2016.
The market continues to expect that global gross domestic product (GDP) growth will accelerate in 2015 (3.0%), 2016 (3.4%), and 2017 (3.4%) from 2014’s 2.0% pace, aided by lower oil prices and stimulus from two of the three leading central banks in the world. The prospect for another year of decelerating growth in emerging markets remains a concern for some investors, who may stillbe waiting (in vain) for China to post 10 – 12% growth rates as it consistently did during the early to mid-2000s. The likelihood of rate hikes in the U.S. in late 2015 and the U.K. in early 2016 is also a potential growth headwind. Still, much stimulus remains in the system, and more is likely from the Bank of Japan (BOJ) and the European Central Bank (ECB), which may help bolster growth prospects in two key areas of the globe. Although China is unlikely to embark on quantitative easing (QE), Chinese authorities have recently enacted a series of targeted fiscal, monetary, and administrative actions aimed at stabilizing China’s economy in 2015 and beyond; more such actions may follow, but fears of a hard landing in China persist.
The Institute for Supply Management (ISM) released its Non-Manufacturing Report on Business for September 2015 on Monday, October 5, 2015, as this Weekly Economic Commentary was prepared for publication. It showed that the service sector remains robust, with the non-manufacturing ISM hitting 56.9, which over time, is consistent with real gross domestic product (GDP) of 3.5%. However, the report, as usual, was largely ignored by market participants, even though non-manufacturing activity (mainly the service sector) represents 70% of the U.S. economy. Financial markets, however, correctly focus more closely on ISM’s Manufacturing Report on Business, as S&P earnings — which over time, drive stock prices — are much more closely correlated to the manufacturing portion of the economy than to the service side. But for those concerned about a U.S. recession, the recent data on both the non-manufacturing and manufacturing ISMs are comforting. As noted above, the non-manufacturing ISM readings of 56.7 in September and 57.3 so far in 2015 indicate fairly robust economic activity continues in 70% of the U.S. economy. The manufacturing ISM data, however, are more concerning. Released last week, the manufacturing ISM for September 2015 came in at 50.2, below the consensus of economists as polled by Bloomberg News (50.6) and the August 2015 readingof 51.1. In fact, the September 2015 reading on the ISM was the lowest since May 2013, and indicates that the manufacturing economy, which accounts for just 30% of the U.S. economy.