Thank goodness this month is over. As January draws to a close, many are ready to throw in the towel as volatility skyrockets and bad news abounds. Don’t be in such a hurry.
Day to day movements in share prices is getting larger and intraday swings in the indexes are even bigger. The difference between the high and low on the S&P 500 Index is an average of 29 points or 1.4% daily. You have to go back to October of last year, when markets sold off, for that kind of volatility.
Wherever you look, negatives seem to be sprouting up around us. This fourth quarter earnings season, for example, has bloodied the noses of many optimistic analysts on Wall Street. As I warned readers in several of my columns over the last two months, the combination of lower oil prices and the rising dollar would have a negative impact on earnings. And yet, for some reason, investors still seem to be surprised.
Let’s stake the impact of the dollar on earnings first. For years, multinational companies have benefited from a weak dollar. As I wrote back then profits and revenues generated from overseas represented the lion’s share of earnings for the majority of companies listed on the S&P 500 Index. It didn’t require rocket science to figure out that these companies would be hurt by the strengthening dollar. Now we are witnessing those results.
From technology to consumer goods and everything exposed to overseas in between, blue chip companies are struggling to defend their bottom lines against this dollar impact. However, companies that generate the bulk of their business domestically are doing just fine thank you.
Then there is the energy sector. Oil prices are dropping toward my previously-stated target of $40/bbl. I still believe that until we get there the overall market will continue to be held hostage by oil’s decline. The good news is that we are only $4 or so away from my target. As for oil’s impact on earnings, the disappointments coming out of the energy sector still loom ahead of us. But remember, it is not only energy companies that are impacted by lower prices. Everything that goes into the energy business from technical support, to steel, to construction faces further declining profits.
The great oil and gas boom in this country over the last few years was also a large reason unemployment was shrinking. Remember, too, that the energy industry represented over 16% of national business capital expenditures. That spending is being cut back rapidly.
And yet, according to the Fed, the nation’s economy is still gathering strength as are gains in employment. Despite the turmoil in the stock market, the Fed is still on target to begin raising interest rates in June. Some investors argue there is a growing disconnect between the risks to the economy poised by the declining oil price and the stronger dollar and the Fed’s increasingly hawkish stance on interest rates.
When all is said and done I believe the benefits of cheap energy, coupled with continued low long-term interest rates and a strengthening economy provide a floor under the U.S. market. Overseas, the stimulus central banks are applying to their economies also supports the largest freeing markets. The present month-long corrective phase in the markets is simply a necessary and useful prelude to further gains in the future.