Last year, US real GDP grew 2.4% primarily driven by personal consumption and fixed investments.
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However, stock markets in 2015 ended up flat.
In other words, US corporations have added one-year worth of retained earnings to their balance sheets without any market price gains.
In early 2016, stock markets have experienced a massive selloff.
However, in our opinion, many of the concerns unnerving investors are faulty.
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The biggest of all these fears is the drop in oil prices.
When prices go up against the fundamentals, they fall as rapidly as they grow. That’s what happened to Internet stocks in 2000 market and housing prices in 2008.
Now, it’s the oil industry’s turn. There was abundant supply of oil from shale producers in the US.
In my opinion, other oil producers at OPEC didn’t factor in the global oil glut or the re-entry of Iran into the oil markets.
At one point, the price of a barrel of oil shot up to $140, and that encouraged more and more drilling.
As a result, there is no room to store the excess oil produced in the US. All those oil tankers are full and floating in the gulf.
Due to this oversupply, prices plunged and opened the door to export oil from US for the first time since the 1970s Arab oil embargo.
Stock Market Impact
Naturally, oil firms have started cutting drilling and slowing capital expenditures.
As a result, the energy sector has been hit hard and those companies represent about 6.6% of S&P 500.
However, every other sector in S&P 500 is benefiting, directly or indirectly, from lower energy costs.
They include chemical companies, fertilizer firms, agricultural interests, airlines, and consumer discretionary and staples sectors.
Last year, US consumers benefited from approximately $129 billion in fuel savings. That works out to about $960 per household.
If you add industrial and transportation sector savings, the benefits to the US economy are enormous.
Cheaper oil is also a big economic boost to energy importers like India and China.
Then there’s the fear of market multiples. As of February 19, the S&P 500 price-to-earnings ratio was hovering at about 20.5, which works out to a 4.86% earning yield.
When compared to the 1.75% yield of 10-year Treasuries, the stock market looks reasonably priced.
Many pundits measure market averages with cyclically adjusted ten-year average earnings. The biggest flaw in this comparison is outlier corporate earnings during the Great Recession in 2008.
If the year 2008 earnings slump is excluded, then the average goes down to very reasonable multiples.
Another fear weighing on investors is the Fed’s monetary policy shift.
Markets turned turbulent right after Fed raised interest rates from zero to 0.25% late last year.
The US economy, in my opinion, is in excellent condition to handle the normalization of interest rates.
Higher interests are not necessarily a bad thing. Due to the ultra-low rates of recent years, lenders were reluctant to lend and savers had little incentive to save.
The Fed’s move also may place further upward pressure on the dollar, given the negative interest rate policy of the European Central Bank and Bank of Japan.
Fears of a Chinese hard landing have also hovered over the markets this year.
Chinese economy slowed a bit in 2015 but is still growing at a healthy pace of 6.8%.
Chinese stocks have cratered, but the country’s equity market is isolated for the most part from the global economy and most foreign investors.
Finally, there are fresh concerns about a possible US recession.
Even though 2016 market started with losses, in my opinion US GDP will advance a little more than 2%.
Savings from energy are evident in the consumer discretionary spending such as automobile sales.
The airline industry is also benefiting from lower energy prices and also an uptick in consumer spending.
The US unemployment is low, wages are slowly increasing and housing permits are up.
These are all good indicators of an economy on solid footing.
Irrespective of the early market losses this year, we see calm after the storm.
In our view, now is probably a good time to keep your feet planted in the market and keep a long-term perspective according to your individual needs.
We believe that later in 2016 markets will bounce back and roll forward.
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