Current Market Conditions and What To Expect

 

stockmWe are eight months into the year and investors feel like they have been put through the ringer. Despite making new highs in the S&P and NASDAQ, we are essentially where we started 2015 – at zero. The twists and gyrations have swung the markets about 7%, from top to bottom, but the gains can’t seem to hold. We have said not to expect the robust returns we have had in the past few years, and that market returns would even out. While we still like the stock market and its potential for the future, we think that the easy returns have already been made. So, what sort of market are we in currently and what should we expect in the near future?

The U.S. economy is showing more signs of life than a last gasp. It might feel like we are going nowhere fast, but the economy is moving forward, albeit slowly, very slowly. Generally, after a recession we see the economy “shoot” forward or get a strong jolt. However, coming out of this latest recession the economy hasn’t followed that pattern and has yet to receive that burst. Earnings are strong due to a decade of improved productivity gains and jumps in technology. Big corporations have learned how to leverage technology to lessen their dependence on employees. In turn, this decreased need for employees may mean longer periods before the effects of wage inflation eat into the economy; thus, a slow, gradual upward shift in the economy.

Europe is not out of the woods, but here too, things are starting to go in the right direction. Draghi’s version of Quantitative Easing has another year to go, and we have to assume the EU will follow a similar path as the Federal Reserve did here in the United States. Whatever the outcome of Greece, its effect cost-wise is negligible to the U.S. economy. China, though ripe with opportunity, is still an emerging market. The NYSE has over a hundred years of history and practice but China is still in its infancy when talking capital markets. However, it is the world’s second largest economy and well on the way to becoming the first.

The focus on China at the moment is the devaluation of the yuan or renminbi (RMB). Until 2005, the yuan or RMB was pegged to the U.S. dollar and the last time it was devalued was in 1994. While the effects of a devaluation on other Asian economies is a topic unto itself, we think the motivation behind the People’s Bank of China’s (PBOC) actions is to get the International Monetary Fund (IMF) to endorse the RMB, or yuan and include it as a reserve currency. The current basket is derived of the U.S. dollar, euro, U.K. pound sterling and Japanese yen. The world currencies that make up the basket are voted on once every five years and the yuan failed to qualify when last reviewed in 2010. Even if the IMF opts not to include the yuan again this year, it is only a matter of time before the organization adds it to the currency basket.

So what does this mean for the U.S. stock market? After 6 years of a bull market where the S&P 500 index was up over 2.5 times without any major correction, it is reasonable for the market to consolidate and move sideways for some period of time. It is unreasonable, however, to assume since the market is up 2.5 times from the bottom that it now must go through a 30% to 50% decline. Markets do not have those kinds of declines without an economic recession, which doesn’t have a high probability of occurring at the present time. As we have said before, on an absolute basis, while the market is not cheap, it is not stretched. On a relative basis as compared to other investment alternatives such as bonds, the market is extraordinarily cheap. While it is difficult to say how long the market can trade in its presently narrow range, we believe when it does break out it will do so on the upside.

The Dumont & Blake Team
August 20, 2015

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