INSIGHTS

On May 23, 2016

AAM Viewpoints - Stay Away From Grisly Bears

Investors have pulled more than $60 billion out of U.S. equity funds since the start of this year.  Compare that to outflows of $85 billion in the 2008 financial crisis and $65 billion during the bear market of 2002.  Flow data for 2016 seems to be magnified, especially given companies themselves are planning to buyback over $600 billion in shares this year.  At the same time, gold is up 21% year-to-date (YTD) capturing almost three quarters of all flows into commodities.  Traditionally, rising U.S. rates, a strong U.S. dollar and benign global inflation have flashed sell signals for bullion. Instead, “crisis” remains one rationale for gold’s ascent, but the question is which one(s) and where.  Debt, negative interest rates, conflict?  In fact, Carl Icahn is betting on a market crash and investors could pull $500 billion out of hedge funds in 2016, both according to the New York Post.  Clearly, sentiment is extremely negative and investing in the stock market appears to be a bad idea to many investors at the moment.  However, uncertainty often creates opportunity and risk is the price you pay for prosperity. 

Despite the overwhelming tone, we believe U.S. market behavior has been fair and reasonable.  Since the fourth quarter 2014 when the Federal Reserve (Fed) ended its quantitative easing (QE3) program, the S&P 500, give or take a few percent, has been essentially flat.  The period has been interspersed with three scary corrections, including the largest sw­­oon in January/ February of this year, but each event was followed by a swift unexpected reversal.  To the misfortune of many hedge fund managers, Warren Buffet was correct when he said, "What we learn from history is that people don't learn from history." 

Many cite the Fed as the market’s party pooper, but if you look more closely, we believe the real reason for the S&P 500’s trajectory over the past 18 months has been earnings.  Coincidently or not, S&P 500 earnings peaked in the fourth quarter 2014 at $119; in 2015 earnings registered $115 and our forecasts suggest $118-$120 for 2016.  Herein lies the likely answer to market performance; certainly not a reason for celebration, but also not a reason for the kind of turmoil many are forecasting and dreading.  That said, if passive investors expect to have any success this year, they had better hope that earnings revisions move higher in the coming quarters because we don’t expect multiples to expand in such a fearful environment with interest rates increases sprinkled on top.

What do we think can drive earnings higher?  1) Global growth; 2) the dollar; or 3) oil prices.  As 2016 unfolds and we look towards 2017, hope alone that earnings will rise may not be a path to fortune.  We at CJL have two encompassing conclusions regarding the earnings problem:

1. Companies that take market share can sustainably grow earnings and

2. In a zero interest rate world, investors will have to pay more for such companies. 

There are companies in the U.S. and around the world that are flourishing, despite the slow economic backdrop and the many uncertainties that pervade.  Companies successfully growing their market share are primarily innovators with loyal enthusiastic customers, financially strong with pricing power, and in most cases, dominant in their industries.  These companies often have the ability to “out muscle” the competition to potentially deliver appreciating earnings and subsequently higher stock prices.  We believe investors should take comfort that such companies can potentially provide a path to investment success over the long-term.     

In the short-term, algorithms, emotion and institutional investors may eat amateur traders for breakfast.  However, over the long-term, we believe the minute-by-minute market information should be superseded by the actual results of the world’s great companies.  Identify, validate and stay on top of the best and we believe the short-term pain of volatility could give way to the assurance of hard fought reward. 

CRN: 2016-0502-5323 R

This commentary is for informational purposes only. All investments are subject to risk and past performance is no guarantee of future results. Please see the Disclosures webpage for additional risk information at https://www.aamlive.com/legal/commentary-disclosures. For additional commentary or financial resources, please visit www.aamlive.com.