Market Commentary First Quarter 2015
After reaching new highs in March, the market retreated broadly with some of the best performing sectors experiencing the most pronounced declines. The dollar/euro trade which worked so well for sometime appears to have faltered. Selling Euros, buying dollars, and investing into higher yielding U.S. assets have been undermined by the rise in the euro from 105 to 109. Given the consensus view that the dollar would continue to rise verses the euro, many investors were surprised and over committed. Consequently, forced selling to cover highly leveraged positions could easily have contributed to market volatility. At the same time, oil prices also reversed direction despite the continued build up in crude inventories to record levels. Again, with the preponderance of investors expecting even lower prices, a directional change is disruptive and costly. It may not be a coincidence that the near-term market peak in March and the low in oil prices, along with the euro reaching its recent low, occurred close together. The change in direction can create disorderly markets even if the changes are only temporary.
The uncertainty quotient has also increased recently as Middle East tensions have risen. The Saudi’s bombing in Yemen, the U.S. warplanes beginning airstrikes against targets in Iraq, and the convoluted Iranian role add to the international cross current from Venezuela, to the Ukraine, to Russia. As a bi-product of the oil and euro events, first quarter earnings estimates have been reduced appreciably. Foreign exchange headwinds on multinationals and the impact of falling oil prices on energy companies should have the largest effect in the first quarter reports. It is the speed of the decline that is the disruptive element. However, in the subsequent quarters, the effects should gradually dissipate. In the meantime, the benefits from lower energy costs on discretionary income and spending should be felt. This phenomenon started to emerge in fourth quarter 2014 when consumer spending rose at a healthy 4.4% annual rate and consumer services were the big beneficiaries. As is typically the case when unexpected negative events occur, analysts are most likely to overestimate the earnings reduction in the first quarter and underestimate the rebound in the second, third, and fourth quarter.
More importantly, economic developments at home and abroad are continuing to benefit from central bank policy. The European Central Bank has embarked upon its quantitative easing program of 60 billion Euros a month. Draghi suggested that European Central Bank policy is bearing fruit. He indicated that while the recovery in the euro area is weak, the short term outlook is more favorable. The weakened euro – in part a function of central bank policy- is helping to stimulate growth through exports and the availability of liquidity.
Most recently, U.S. monetary policy took on a slightly more dovish tone. The Federal Reserve Open Market Committee at its March meeting lowered the near-term inflation forecast and projected a lower Federal Funds rate later this year and into 2016.
In our judgment, the Fed remains sensitive to international developments and would like to avoid being in conflict with the “very easy” accommodative policy of the European Central Bank and the Bank of Japan. Moreover, first quarter GDP growth should be tepid at best. The weather and the west coast port strike will play havoc with the numbers. It is generally anticipated that a “bounce back” will take place in the second quarter, but this will not become fully apparent until sometime this summer. Consequently, an autumn inflection point for a rate move seems still to be a likely scenario. The Fed is attempting to articulate the nature of the launch path for rates in an attempt to establish a framework for a return to some semblance of normality. A slow, non-systematic