January turned out to be a very negative month for the markets. February did not start out any better, but we have had a recent rally which was welcomed. Here is how March is shaping up.
There are three main factors the markets are worried about.
The first factor is China will continue to be in the news as investors think growth in this country is slowing down, but are not sure by how much. Chinese economic information comes mostly from their government, and not everyone trusts their numbers. Their growth is stated to be at 7%, but many people think it is closer to 6% or maybe lower. The Chinese government has been showing strong support to defend their markets which is a good thing.
A second reason for falling markets is the price of oil. The price may go lower, before it eventually recovers to a price which is above its cost of production for most producers. The oil sands in Canada need a price per barrel of $45 to $60 to make a profit. There is a glut of oil on the world market, but demand is increasing and investment in new supply is slowing. Many investors seem to equate the lower price for oil with a slowing global economy, instead of oil being oversupplied. We had some relief last week, but fundamentally supply has to come back into alignment with demand. Currently the stock market is following the price of oil at a 90% or more correlation which means many other important and often positive market factors are being ignored. Another concern related to the low price of oil is bank exposure to oil company loans that may default in markets around the world.
Here is a video from TD economics showing a pathway to oil price recovery this year - http://tdwealthmedia.com/videos/crude-oil-pathway-to-re-balancing-in-201...
If we look at economies minus the energy sector, the growth looks much better in the 5% range. However the loss of wealth of the energy companies, and the loss of their support to the market, has been a huge negative. Much of the loss from oil prices is already priced into the market. A potential recovery in oil prices would cause the energy markets to spike up in price.
Thirdly, investors wonder if the US Federal Reserve made a mistake in increasing interest rates late in 2015. However, the Fed would not have raised interest rates in the US if they did not feel that the US was on a sustainable growth path. The US has a projected growth rate of about 2%, and Canada is currently at about 1.4% for 2016. The longer the price of oil remains low, the more damage will be done to major oil producing countries like Canada. It is possible that continued low prices in oil will drive Canada into a recession. Low oil prices should be a boost to oil consuming countries which is the majority of other countries.
Growth in Canada, the US and the rest of the world continues to be slower than investors would like.
The Canadian stock market has underperformed the United States for five years now and was down about 11% for 2015. Many areas have been hard hit as the low oil prices affected Canada in particular. If there is any firming and improvement in the price of oil as 2016 progresses, Canada could have a good year for investors by just regaining some lost ground and potentially outperform the US. Many Canadian companies pay a high dividend rate of 3% or more. That is 3 times more than an investor is currently being paid for long bonds, and gives an investor a chance to add that to the growth in value of their stocks when sentiment improves.
Europe had some of the best stock market returns last year, and their growth looks reasonable for 2016.
Europe can also be important for diversification across different economies and asset classes. We never know when we will be surprised to the upside or downside, and diversification has been one of the best defenses.
Bank of Canada governor, Stephen Poloz, left the interest rate unchanged instead of decreasing it. He was expressing confidence that Canada will work its way through the current headwinds it is facing, while acknowledging the problems that exist. He mentioned that significant stimulus by the Canadian government can be one factor that may accelerate a recovery from our excess capacity.
As the price of stocks have dropped significantly, new opportunities are created to purchase companies that have become undervalued simply because the entire market was selling off. Fund managers look at market volatility as a chance to improve their positions in their portfolios. The selling pressure will eventually reverse.
Investor’s overall concern is if we are going into a global recession? With the four largest economies, United States, China, Europe and Japan still benefiting from stimulus and positive growth rates, most economists think this is unlikely. United States is ending its current earnings reporting season, and the results have been fairly positive and have beaten estimates. Sales have slowed the last several quarters, but companies have adjusted by cutting costs. So a recession seems unlikely for this year for the United States. Sentiment is very negative still in the market, and stocks have dropped in value peak to trough, up to 20%. Many see those factors as signals to be in the market, as investors want to buy stocks when prices are low, and pessimism is high, as long as one’s time horizon is at least several years.