Markets in 2016: How to Separate Signals from Noise

February 09, 2016

Jim McDonald

Daniel Phillips

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So far, the markets have been even noisier in 2016 than we had expected back in December: Developed-markets equities fell nearly 6 percent in January, commodities declined 1.7 percent, and emerging-markets stocks were down approximately 6.5 percent.

Has the global economy really hit the skids that much to justify such a sharp fall in asset prices? Were investors behind the curve in realizing how bad growth has become? Or have they become too gloomy as downward momentum feeds on itself? Successful investors ignore the market moves at their own peril. Yet although financial markets may be rational over the long term, they certainly display bouts of irrationality in the short term. Noisy markets with heightened volatility in 2016 will raise the stakes on divining the fundamental outlook. Let’s look at five areas:

Global economy. At this point, the data don’t look that much different from how they looked for most of 2015. The U.S. economy shows strength in the labor and lending markets, whereas business spending and inventory excess are slowing growth. European momentum continues to be steady, with the most recent German Ifo business climate index showing surprising improvement. The outlook for emerging markets is clouded by China, for which official economic statistics show moderate deceleration, though private statistics show a more significant slowdown. Although it seems unlikely that China’s growth has suddenly hit the wall, as some bears have been claiming, the high level of debt outstanding across the economy is cause for concern.

Commodities. The plunge in prices, especially in the oil markets, is a market signal creating a great deal of consternation. Oil demand actually accelerated in 2015, but surging supply has overwhelmed demand and pummeled prices. Research from the European Central Bank supports our contention at Northern Trust that oil’s price drop has been caused primarily by the supply surge — mitigating the concerns that the oil markets are signaling a major change in global growth. A wildcard for 2016 will be whether the positive effects from lower oil prices will finally broaden from European shores to the U.S. and to emerging markets.

U.S. equities. A meager 1.3 percent total return for the S&P 500 in 2015 might suggest a quiet year. That wasn’t the case. Instead, 2015 was a story of haves and have-nots. Growth beat value by more than 9 percent, and large caps beat small caps by nearly 6 percent. Consumer discretionary, the best-performing sector, beat the worst-performing, energy, by more than 30 percent. The breadth of strong performers was narrow, with the so-called FANG stocks (Facebook, Amazon, Netflix and Google/Alphabet) contributing more than 100 percent of the market’s returns, since other stocks had a negative return in aggregate. The S&P 500 started 2016 by falling 5 percent, its tenth-worst January on record. Volatility will stay with us for the short term. We remain constructive on U.S. equities, however, as nonenergy earnings continue to grow and as the magnitude of the earnings drag from the energy sector weakness and dollar strength eases in 2016.

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