January was a disappointing month for investors, with the S&P 500 index down roughly 4% for the month as of 10am on Friday, January 31.
January is a closely watched month, as there is some historical correlation between the market’s performance in January vs. the entire calendar year. Statistics show that “up” markets for the first five trading days of January, especially coupled with an “up” market for the entire month of January, tend to overwhelmingly coincide with “up” markets for the year. Conversely, “down” markets in January — the first five trading days coupled with the entire month — can tend to indicate a more challenging market environment, although the statistics are not nearly as compelling or conclusive. For more details, please see this article.
We can point to a number of obstacles the market has had to face this month:
1. Concerns about Emerging Markets around the world, with currency instability in places like Turkey and Argentina, as well as manufacturing data out of China.
2. Selling pressure as some investors may have chosen to sell last year’s “winners” at long term capital gains tax rates instead the more significant short term capital gains rates.
3. Volatility in reaction to Fed policy, specifically the continued tapering of the Fed’s asset purchase program.
4. The transition of the FOMC Chairmanship from Ben Bernanke to Janet Yellen.
5. Disappointing economic data in a few key areas, such as the recent jobless claims increase, lower pending home sales, lower durable goods orders, and slightly disappointing Chicago PMI — all of which point to an economy that is either slowing the pace of growth or perhaps experiencing a short-term pause in the trajectory of growth.
Our observation would be that, while volatility has returned to the market this month, we believe we’re heading into a more “normal” market environment — one in which bad news is bad for the markets, and good news is good for the markets. Contrast this with 2013’s market, where for most of the year, bad news meant the Fed would delay tapering their asset purchase program, which likely fueled part of the market’s steep rise in 2013.
Although it’s too soon to tell how deep this market pullback could become or what economic trends will materialize over the year, we still believe there are plenty of reasons for optimism in earnings and economic growth. For example, despite many of the disappointing pieces of economic data, there were a few positives, such as:
1. a GDP reading that was in line with expectations;
2. a larger than expected increase in consumer confidence;
3. Although there were several high profile earnings misses in the quarter, roughly 70% of companies beat their earnings expectations, which is slightly higher than the historical average.
4. We believe that the Fed’s decision to taper, while possibly difficult for the market to digest in the short term, is an encouraging development for two reasons: first, it allows markets to function in a more normal environment, with greater certainty about Fed policy; second, the Fed has signaled that the main reason for tapering is it’s belief that the economy is improving across the board and therefore needs less artificial stimulus from the Central Bank.
5. We continue to see meaningful increases in dividend payouts by S&P 500 companies, which should be helpful for income investors and can be perceived as a sign of stronger corporate balance sheets in many cases. These dividend increases should also help to offset the continued pressure on bond interest rates for income investors.
We will continue to keep a close watch on the economy, markets, and our clients’ investment allocations over the coming months, but ultimately, we’re comfortable with a market that continues to act more normal and healthy, even if it does come with the undesirable side effect of increased volatility.
Please note that nothing in this note should constitute an investment recommendation.