October 2016 Monthly Insight: Potential Volatility on the Horizon

Posted By T. Lee Sherbakoff, CPA/PFS, CFP® on Oct 15, 2016


“In times like these, it helps to recall that there have always been times like these.”Paul Harvey

As we enter the fourth quarter of 2016, it’s worth noting that this long-running bull market has now lasted nearly seven and a half years.  If that seems hard to believe, let us remind you that the S&P 500 index hit the Great Recession low of 677 on March 9, 2009.  Yet on September 30, 2016, the market closed at 2,168, up over 220% since the 2009 bottom on a price basis, not including dividends.  Since we’re now into October, we can’t help thinking about the month’s troublesome reputation with many investors, due to significant market moves from past Octobers. But again, let us remind you that, regardless of previous market lows, the market has always rebounded.

The fourth quarter of 2016 promises to be extremely volatile in the markets.  We want to highlight three trends that, in all likelihood, will add additional volatility to the markets.  While we know volatility will be the norm, however, it’s impossible to guess exactly when and to what extent the markets will fluctuate—so there is really no opportunity to time the market.

Corporate Earnings

Companies have been reporting negative quarterly earnings growth over the last five quarters.  As of September 30, the market was trading at a price-to-earnings multiple (P/E ratio) of 16.8x.  This means that investors were paying $16.80 for one dollar of earnings.  The 25-year average of the P/E is 15.9x, so the markets are somewhat over-valued based on this 25-year history.  The P/E ratio has been rising, but corporate earnings have been flat, if not negative.  Thus, investors have been paying more for the same dollar of earnings.  So, with valuations somewhat elevated, corporate earnings need to grow to further the market along.  In short, investors are expecting companies to show earnings growth, which would lower the P/E ratio of the market.

Two headwinds for the market have somewhat stabilized over this calendar year.  First, price volatility in the oil market has subsided, which should allow the energy and basic materials sectors to experience earnings growth.  Second, the U. S. dollar has remained relatively stable, which should help exporters and the industrial sector to grow earnings.  However, should the upcoming earnings season disappoint us once again, we can expect additional volatility in the market.

The Federal Reserve

In September, The Federal Reserve decided once again not to raise interest rates.  Interestingly, three members of the 12-member Federal Open Market Committee dissented the decision to hold rates steady.  Chair Yellen is known to seek consensus in these decisions, yet apparently there is concern among some Fed officials that the central bank is waiting too long to bring rates to more normal levels.

In prepared comments after the September meeting, Chair Yellen said that she saw no reason to rush into raising rates. The economy keeps strengthening without overheating.  “We’re generally pleased with how the economy is doing,” she said at a news conference.  “The economy has a little more room to run than might have previously been thought.  That’s good news.”

Now, Fed watchers believe the most likely scenario is for the Fed to raise interest rates at its December meeting.  Although the Fed will meet in November, its meeting concludes six days before the presidential election, and the Fed is not inclined to make a hike then, although it claims not to consider politics in making its decisions.  The Fed’s December meeting is scheduled for December 13-14. We can expect heightened volatility in the markets around that time.  And, as we have cautioned you before, trying to anticipate Fed moves or the direction of short-term market moves is futile.

The Election

The U. S. has held presidential elections every four years since 1788, when George Washington was elected.  President Obama is the 44th President, yet the U. S. has had 56 presidential elections.  According to recent polls, many people wonder how, out of a population of 300,000,000 people, candidates Trump and Clinton are the best their respective parties can put forward.  However, this is not the first time the U. S. has seen divisive candidates in a presidential election.  Our nation has proved over and over again that it is able to weather many storms and thrive under leaders of all stripes—conservative and liberal, strong and weak, popular and not. We have little doubt this will be the case this time around.

We are not providing an endorsement of any candidate.  Short-term volatility shouldn’t affect how we vote in November.  Our nation faces much more pressing problems.  We do, however, want to monitor important events that may create some ripple in the financial markets, even if those ripples are brief in nature.

That leads to our final point.  Keep your eye on your longer-term financial plan. While we have seen some volatility tied to the election, it’s possible things could get a bit bumpier as we approach Election Day. Markets go through choppy periods over the short-term, but a disciplined approach to portfolio management is the straight line to your financial goals.

One thing is abundantly clear—periods of sheer boredom in the markets, such as we have experienced in the last month or so (the short-term), will eventually come to an end.  As one ironic philosopher once said, “May you live in interesting times.”

We hope you’ve found this review to be educational and helpful. As we like to emphasize, it is our job to assist you. Thank you very much for the trust and confidence you’ve placed in our firm.  We treasure our relationships with our clients, and seek to serve a few more people like you.  If you know of someone who would benefit from our advice and services, we would welcome an introduction.

 

DISCLOSURES: The information provided in this letter is for general informational purposes only and should not be considered an individualized recommendation of any particular security, strategy or investment product, and should not be construed as investment, legal, or tax advice. The Nalls Sherbakoff Group, LLC makes no warranties with regard to the information or results obtained by third parties and its use and disclaim any liability arising out of, or reliance on the information. These indexes reflect investments for a limited period of time and do not reflect performance in different economic or market cycles and are not intended to reflect the actual outcomes of any client of The Nalls Sherbakoff Group, LLC. Past performance does not guarantee future results.