Whereas stocks actually recorded modest gains in the first quarter of 2016, with the Standard & Poor’s 500 index gaining 1 percent, investors felt whipsawed by the wild ride, with the market dropping 11 percent during the first part of the quarter before fully reversing those losses with a powerful rally.
So, what was it all about? In the early weeks of 2016, investors became increasingly worried about the outlook for economic growth worldwide. China and the other emerging markets were at the epicenter of concerns; commodity prices plunged again, and stock markets around the world followed. Markets appeared to be discounting an imminent recession in the U.S. too, with credit spreads widening alarmingly.
As is often the case, the worst fears weren’t met. Economic data from the U.S. suggested that growth was actually continuing at a modest but steady pace, while the Federal Reserve’s commentary on the future direction of monetary policy also served to soothe the alarm. Selling pressures from short-term investors seemed to abate, shorts were covered, stock prices recovered sharply, and even commodity prices showed signs of life. Market volatility was certainly higher than normal, although by no means unprecedented.
Overall, risk aversion has been the dominant theme. Commodity-related stocks continued to plunge in the first part of the quarter before staging a recovery from multiyear lows. Freeport-McMoRan, the best performer in the S&P 500, for example, traded as low as $5, down from its peak above $60 in 2012, before ending the quarter at $10.
Ultimately, the real winners for the quarter were those stocks backed by stable, highly predictable businesses and paying attractive dividends. These names hugely outperformed in the early weeks and didn’t surrender much relative performance in the rally.
Utilities ended with gains of 16 percent, and telecom stocks rose 13 percent, beating the indexes by a very wide margin. As depressed cyclical stocks recovered, value actually beat growth for the quarter, with growth held back by very weak health care stocks. This sector had been highly favored by many until summer 2015. Since then, however, the growing controversy over drug pricing and the collapse of specialty drug manufacturer Valeant Pharmaceuticals International, whose stock has plummeted more than 90 percent since August, have weighed heavily on the group. Overall, health care stocks lost 6 percent, but the pain was more acute in many places. Small-cap biotechnology stocks, for example, fell an average of almost 30 percent.
Although the megacap social media stocks held up fairly well, there were some severe price declines among other technology leaders. LinkedIn shares, for example, fell more than 30 percent after the company gave more cautious guidance on future growth prospects in February.
So, where do we go from here? Our forecast at J.P. Morgan Asset Management for S&P 500 earnings in 2016 is now $119, suggesting very modest growth this year and about 4 percent lower than we had forecast three months ago. Most of this decline is because of lowered expectations for energy and other commodity sectors, which isn’t really news at this point. Energy stocks are actually higher so far this year.
We’ve also tempered our near-term expectations for the financial sector, with interest rate rises seemingly less likely to provide relief to net interest margins and the capital markets businesses off to a very rough start.
Elsewhere, our near-term expectations are little changed. We still see modest growth in the U.S. economy, solid trends in consumer spending and the drag of a strong dollar moderating later this year. Long term, we’ve taken a more cautious approach toward, for example, investment bank profitability but have actually raised long-term numbers for some of the winners in social media and in home improvement retail, a rare retail sector largely protected from the threat of e-commerce. The picture is one of moderate underlying growth masked in the first half of the year by the headwinds of a strong dollar and weak energy prices — drags that will likely fade later in 2016.
For this, investors are paying around 16 times earnings — reasonable value in a historical context — and very good value versus most fixed-income alternatives. With long-term interest rates dropping and dividends continuing to rise, more than half of the stocks in the S&P 500 now have dividend yields higher than the yield offered by ten-year Treasuries. That’s a picture unrecognizable to investors used to the norms of the past 30 years.
Yes, the U.S. economy faces stiff headwinds from both high levels of debt and from demographic changes, Europe looks worse, and emerging markets seem to have shifted into a much lower gear for the foreseeable future. Most companies, however, are managing to generate a huge amount of cash and are focused on shareholder returns — with the ever-growing band of activists snapping at the heels of any that disappoint. So investing in stocks, even against a backdrop of modest underlying growth, continues to look sensible to us.
Paul Quinsee is chief investment officer of U.S. equities at J.P. Morgan Asset Management in New York.
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