Market Perspectives

 Scott Smith, CIMA®

Elephant Donkey PoliticsThe popularity of Donald Trump and Bernie Sanders reflects an underlying distrust of the establishment candidates from both Democrats and Republicans.  If there is a lesson to be learned from the popularity of these candidates, perhaps it’s that political correctness and status quo policy from both sides is not resonating with voters.

While the economy has certainly come a long way since the beginning of the Obama administration (and the financial crisis), it’s hard to argue that the economy is reaching its full potential.  There is a lot more that can be done to improve the growth of the economy and the answer does not rest with the Federal Reserve, but in the White House and in the halls of Congress.  Effective policymaking isn’t just needed here in the United States, but across the entire developed world that is struggling to revive growth despite zero (and negative) bound interest rates.  Now more than ever, we need leadership in politics that unites and brings results.

What’s clear is that corporate managements are accountable to shareholders and they are not waiting for the political or economic environment to change.  Instead, they are increasingly taking matters into their own hands by engaging in merger and acquisition (M&A) activity as a means to reduce corporate tax liability, remove duplicate layers of cost, and improve earnings growth.  Historically, high M&A activity is usually associated with a robust economic environment, but I’d argue that it’s a combination of a lack of growth and low interest rates that are catalyzing these M&A trends.

In 2015, global mergers and acquisitions surpassed the $5 trillion mark for the first time ever 1.  Even with all the volatility so far in 2016, there have been $48.3 billion in U.S. targeted cross-border M&A volume, which is at the highest level YTD since 1999 1.  Despite the doom and gloom portrayed in the media, these are tangible proofs that global capitalism remains alive and well.

Another area that we began to see positive fruits from is retail sales.  For several months in 2015, there were many (myself included) scratching their heads as to why we didn’t see a bigger bounce in retail spending as a result of lower energy prices.  One month doesn’t make a trend, but it’s nice to see growth get back in the +3% range (shown in the chart below).  The longer energy stays low, the more likely this “consumer dividend” will pay off thru 2016.

Global M&A Volume

US Retail Sales

As we reflect on the market volatility, it’s a reminder of the risks that happen when the Federal Reserve raises interest rates while the rest of the world’s central banks are moving in the opposite direction.  This divergence has clearly put pressure on manufacturing and other export oriented industries in the U.S., as well as foreign countries with dollar-denominated debts.  The volatility was essentially the market giving the Federal Reserve a message to slow or stall further interest rate increases until the global growth picture improves.  The volatility was also a message to equity investors to temper the price they pay for a dollar of earnings, particularly since earnings growth estimates for 2016 are moving lower, not higher.

Despite the volatility, our message since the beginning of the year has been simple and consistent:  the parts of the U.S. economy doing well (jobs/spending/services) should outweigh the parts of the U.S. economy that aren’t doing well (exports/manufacturing/energy).  As such, we do not foresee a recession for 2016 and highlight the wisdom of Nobel Prize winning economist Paul Samuelson when he said:  “The stock market has predicted 9 of the past 5 recessions.”

So how did our equity fund selections hold up in the recent market volatility?  We’re pleased to report that all except one outperformed their benchmark index.  Given growing investor fixation on the superiority of passively managed index funds, it’s nice to see our actively managed fund selections show resilience amidst the market volatility.  This speaks to our belief that what you make in up markets matters less than what you keep in down markets.

1—Source:  Dealogic