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2015 November Financial Market Update

— November 30, 2015 Focusing on Earnings Historically, stocks have performed admirably during the fall, winter, and early spring. Of course, Figure 1 simply illustrates the average monthly and average median returns going back to 1970. Returns during any particular month may vary considerably.

Case in point, October’s rebound far outpaced the historical average, but it did not prevent investors from nibbling away at U.S. stocks during November – see Table 1. Taken together, the S&P 500 Index is just above the level seen prior to the late August selloff. That said, if we shift our eyes away from the short-‐term, we see a market that has an upside bias over the longer term – see Figure 1.

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Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov DecDATA SOURCE: ST. LOUIS FEDERAL RESERVE

LAST DATE: NOV 2015, DEC RETURNS THRU 2014

S&P 500 Index Monthly Average Returns 1970 -‐ 2015

AverageMedian

Fig. 1

Charles Sherry Director, Institutional Education Group Blue Ocean Global Wealth 51 Monroe St., Plaza West 06 Rockville, MD 20850 Tel: 720.308.4560 [email protected]


Table 1: Returns of key indexes and assets November Return* % 2015 YTD Return % DJIA1 +0.32 -‐0.58 NASDAQ Composite2 +1.09 +7.87 S&P 500 Index3 +0.05 +1.04 FTSE Developed ex North America Index4

-‐1.61 -‐0.89

Bond Yields Yield* -‐ % a/o Nov 30, 2015 Yield -‐ % a/o Dec 31, 2014

3-‐month T-‐bill 0.22 +0.14 0.04 2-‐year Treasury 0.94 +0.19 0.67 10-‐year Treasury 2.21 +0.05 2.17 30-‐year Treasury 2.98 +0.05 2.75 Commodities Nov 30 Price, Monthly

Change* Year end 2014

Oil per barrel5 $41.68 -‐5.59 $53.27 Gold per ounce6 $1,061.90 -‐80.45 $1,206.00

Sources: U.S. Treasury, MarketWatch, St. Louis Federal Reserve, CNBC *Includes monthly change: October 30, 2015 through November 30, 2015

One of the key drivers of stocks has historically been corporate profits and expectations of corporate profits. Please see Figure 2, which is an updated review of last month’s illustration.

Last Date: S&P 500 Index -‐ Nov 2015; EPS (earnings per share) for the S&P 500 Index through Sep 2015

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S&P 500 EPS in $S&P 500 Index

Data Source: Econ-‐Yale-‐Online data Robert Shiller

S&P 500 Index and S&P 500 Earnings Per Share

S&P 500 Index

As reported EPS (earnings per share) S&P 500 Index

Fig. 2


There are several takeaways from Figure 2. For starters, the broad-‐based S&P 500 Index has closely tracked corporate earnings for decades. Since 1960, the correlation between S&P 500 earnings and the underlying index (monthly basis) is an extremely high 0.93, where 1.0 would mean the two variables move in lockstep, 0.0 would mean the two variables have absolutely no relation to one another, and -‐1.0 would mean they move in the exact opposite direction. Extend the regression back to 1900 and the correlation rises to 0.95. Next, note that earnings “seemed” to get ahead of the S&P 500 Index in the late 1970s, while shares caught up and far exceeded earnings during the late 1990s. The late 1970s was marked by high interest rates and very high rates of inflation, which diminished the appeal of stocks. In other words, stocks temporarily sold at a discount to corporate profits. But the pendulum began to swing the other way in the 1980s (and especially the 1990s) as interest rates trended lower over the long period (St. Louis Federal Reserve). A strong economy in the 1990s, which aided profits, and slowing inflation (U.S. Bureau of Labor Statistics) encouraged a stampede into stocks. By 2000, equity prices had gotten well ahead of earnings. While the variables in Figure 2 are not completely drawn to scale, there is some sense that earnings have been playing catchup to stocks since the 2000 bubble. Still, the biggest conclusion we can draw is the historically close relationship between corporate earnings and stock prices. While recessions are inevitable, they are temporary. Given expectations the economy will expand over time as it has for over 200 years, longer-‐term profits would also be expected to rise. Key variables that may influence earnings over the next year No one can accurately forecast where stocks are headed in the short-‐term. As the legendary baseball manager Casey Stengel once quipped, “Never make predictions, especially about the future.” It’s a key reason why diversification within and among several assets classes is preferred to market timing by most long-‐term investors. Put another way, imperfect mathematical models + imperfect information are bound to have a margin of error, sometimes a significant margin of error. But a well-‐diversified investment strategy helps to minimize risks over the longer term.


*Assumes the Q4 2015’s forecast of a decline in earnings plays out

That said, Figure 3 illustrates that most companies have managed to top conservative analyst forecasts (right side of the axis). More importantly, earnings are set to decline 0.8% in Q3 2015 (left axis) and are forecast to drop 3.1% in the current quarter (Thomson Reuters as of November 30) before rebounding next year. Two huge themes The strong dollar has hurt revenues at the large multinationals (FactSet), as sales in local currencies must be translated back into stronger dollars. While the pain of filling up at the gas pump has diminished considerably, the energy sector has been hit hard. According to Thomson Reuters, energy profits have fallen 57% during Q3 versus one year ago. Since energy is one of ten sectors in the S&P 500 and it accounts for 7.1% of the index (as of November 30, 2015 per S&P Dow Jones Indices), it has had a significant impact on corporate profits. According to FactSet, weakness in energy has reduced Q3 S&P 500 earnings growth by seven percentage points. Looking ahead, analysts are forecasting an uptick in corporate profits in 2016. It would create a tailwind for stocks, but earnings forecasts going out more than one quarter are dicey at best given the many variables that influence the bottom line. These include oil prices and the value of the dollar. But two key assumptions are being used: stability in oil prices and stability in the dollar. These are big ‘ifs.’ What if oil plunges to new lows amid a continued oversupply of crude?

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Corporate Earnings

S&P 500 Earnings -‐ percent change from one year ago

Beat analyst expectations

Percent Percent

Consensus Forecast

2 quarter earnings recession*

Fig. 3

63% LT avg


Figure 4 illustrates that oil prices have typically gone through long cycles. If we go back to the 1970s, oil was in a long upward trend before peaking in the early 1980s.

The price of West Texas Intermediate (WTI) crude oil is the benchmark for U.S. crude. It cannot be purchased directly. Past

performance does not guarantee future performance.

Are we in a long-‐term bear market for oil? Possibly, but many variables make it difficult to determine where crude might be headed. Will Saudi Arabia continue to pump at full throttle? Will geopolitical events in the Middle East affect prices? If prices begin to perk back up, will U.S. oil firms in the shale fields quickly respond with new output and once again depress prices? Oil is priced in dollars when sold around the globe. Will strength in the dollar help keep a lid on prices? Will low prices encourage driving and domestic demand for oil? As you can see, there are many factors that influence prices. Speaking of the dollar, what if the long-‐anticipated cycle of gradual Federal Reserve rate hikes begins in December as most expect? Rising rates make dollar-‐denominated investments more attractive to foreign investors. Moreover, the U.S. economy’s relative outperformance also adds to the luster of the greenback, as foreign capital looks for the best return around the globe. The Dollar Index is at its highest level in over a decade – see Figure 5. If the dollar hasn’t peaked, it will continue to hamper earnings of U.S. firms that conduct a large share of business abroad.

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DATA SOURCE: ENERGY INFORMATION ADMINISTRATION LAST DATE: NOV 27, 2015

WTI Crude Oil Spot Price

Bear market

Bull

New range?

Fig. 4


The Trade-‐Weighted Dollar Index is a basket of currencies made up of the larger U.S. trading partners. It cannot be purchased

directly. Past performance does not guarantee future performance.

However, here’s where it gets tricky. Historically, U.S. stocks have outperformed during dollar bull markets versus dollar bear markets (Schwab Center for Financial Research). In other words, a stronger dollar has historically been a reflection of relative U.S. economic outperformance versus the global economy and that has aided stocks. 1 The Dow Jones Industrials Average is an unmanaged index of 30 major companies which cannot be invested into directly. Past performance does not guarantee future results.

2 The NASDAQ Composite is an unmanaged index of companies which cannot be invested into directly. Past performance does not guarantee future results.

3 The S&P 500 Index is an unmanaged index of 500 larger companies which cannot be invested into directly. Past performance does not guarantee future results.

4 The FTSE Developed ex North America Index is an unmanaged index of large and mid-‐cap stocks providing coverage of developed markets, excluding the US and Canada. It cannot be invested into directly. Past performance does not guarantee future

results.

5 New York Mercantile Exchange front-‐month contract; Prices can and do vary; past performance does not guarantee future results.

6 London Bullion Market Association; gold fixing pricing at 3 p.m. London time; Prices can and do vary; past performance does not guarantee future results.

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12/30/1994 12/30/1999 12/30/2004 12/30/2009 12/30/2014Data Source: St. Louis Federal Reserve Last Date: Nov 27, 2015

TRADED-‐WEIGHTED DOLLAR INDEX: MAJOR CURRENCIES Fig. 5


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other transactions. Any such request, orders or instructions will not be accepted and will not be processed.

All items discussed in this report are for informational purposes only, are not advice of any kind, and are not intended as a solicitation to buy,

hold, or sell any securities. Nothing contained herein constitutes tax, legal, insurance, or investment advice.

DISCLOSURE: Investing involves risk including the potential loss of principal. No strategy can assure success or protects against loss. Past

performance is no guarantee of future results. Asset allocation does not ensure a profit or protect against loss. There is no guarantee that a

diversified portfolio will enhance overall returns or outperform a non-‐diversified portfolio. Diversification does not protect against market risk.

Please note that rebalancing investments may cause investors to incur transaction costs and, when rebalancing a non-‐retirement account,

taxable events will be created that may increase your tax liability. Rebalancing a portfolio cannot assure a profit or protect against a loss in any

given market environment. Fixed income investments are subject to various risks including changes in interest rates, credit quality, inflation risk,

market valuations, prepayments, corporate events, tax ramifications and other factors. Non-‐U.S. securities markets involve possibly greater

risk of political instability and greater currency risk in addition to having been more volatile. These risks can be accentuated in emerging

markets. Commodities investments are speculative and involve special risks related to weather and international political and economic

developments. Equity investments tend to be volatile and do not involve the guarantees associated with holding a bond to maturity.

Alternative investments may not be suitable for all investors and should be considered as an investment for the risk capital portion of the

portfolio. Tactical allocation may involve more frequent buying and selling of assets and will tend to general higher transaction cost. Investors

should consider the tax consequences of moving positions more frequently. Beta measures a portfolio’s volatility relative to its benchmark. A

Beta greater than 1 suggests the portfolio has historically been more volatile than its benchmark. A Beta less than 1 suggests the portfolio has

historically been less volatile than its benchmark.

Past performance is not a guarantee of future performance. Different investments involve different degrees of risk, and there can be no

assurance that the future performance of any investment, security, commodity or investment strategy that is referenced will be profitable or be

suitable for your portfolio.

The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or

complete. The information contained in this report does not purport to be a complete description of the securities, markets, or developments

referred to in this material. Any information is not a complete summary or statement of all available data necessary for making an investment

decision and does not constitute a recommendation.

Before making any investments or making any type of investment decision, please consult with your financial advisor and determine how a

security may fit into your investment portfolio, how a decision may affect your financial position and how it may impact your financial goals.

All opinions are subject to change without notice in response to changing market and/or economic conditions

Copyright © 2015

Financial Jumble, LLC

Blue Ocean Global Wealth

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november market commentary 2015 - blue ocean global wealth€¦ · ! insight.)) clarity.)) purpose....

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