We have a down January, an up February and so far a down March.
February saw the market recover from January’s losses. Despite the positive performance, February still frustrated investors. There were 11 down days and only 8 up days in the month’s trading.
It certainly illustrates how hard it is to time the market. In February, an investor had to be in the whole month to achieve the upside.
March has not started off well. Friday’s 279 point rout has left the market down 1.6% in March.
We have a down January, an up February and so far a down March. It feels like the market is sensing constraints.
Concerns about earnings and liquidity
I have written several times in this column that in the long-term, earnings, and liquidity drive markets. There are real concerns about these two factors.
The 50% decline in oil prices has caused a rapid decline in earnings estimates for oil producers and related oil service companies and vendors. Energy companies make up 16% of the S&P500. FactSet has estimated that for 2015, S&P500 energy companies will have an earnings decline of almost 54% from 2014 levels. The weakness in oil prices will undoubtedly put pressure on overall S&P500 profits.
The market right now trades at 17 times 2015 earnings estimates. While not at greatly extended levels, a P/E of 17 is not cheap. A high P/E makes the market vulnerable to downward estimate revisions. If oil prices do not revive, and a prolonged slump is felt in the “Oil Patch”, the market will have difficulty moving upward.
Labor Department reports a larger than expected increase in employment
Yesterday’s Labor Department jobs report for February showed a much larger than expected increase in employment. Some 295,000 people found work.
Wages also budged higher. The strength of the report has given investors concern that the Federal Reserve will increase short-term rates sooner and higher than previously expected.
Will interest rates increase?
All else constant, higher interest rates are not good for stocks and especially not good for bonds. Fed Funds futures contracts are implying a 22% chance of a rate hike at the June 17th Fed meeting.
There is now a 91% probability that rates will be higher by the end of the year by at least 0.25%.
While earnings and interest rates are a concern, they do not necessarily mean a bear market is imminent. Nor does it mean that investors should sell all their positions. However, I do think that caution is warranted and perhaps an increase in cash in customer accounts should be considered.
The US economy, outside energy, appears to be doing well. Low oil prices and more jobs should be a plus when it comes to consumer spending, which is 70% of the economy.
Bear markets usually do not appear when the economy is not heading into a recession. As to interest rates, the speed and absolute level of rates matter most. Historically, the markets weather the first rate increase rather well.
There is also the question of how long oil prices will remain depressed. I’m still in the bull camp but at a P/E of 17, the market is suspect in the short-term.
— Ian Green, Pendragon Capital Management
Subscribe to Pendragon's Newsletter
Note: This blog article is intended for general informational purposes only. Nothing in it should be construed as, and may not be used in connection with, an offer to sell, or a solicitation of an offer to buy or hold, an interest in any security or investment product.