After November 8, 2016, the markets will focus on a singular remaining uncertainty for 2016 – i.e., the Federal Reserve’s Open Market Committee’s (“FOMC”) policy decision on December 14th. Given the timing of the meeting, many market commentators have compared this year’s Fourth Quarter with that of 2015. The market selloff that greeted investors in this year’s First Quarter was triggered, according to some pundits, by the Fed’s rate increase in December 2015. We believe this comparison is weak, at best, and misleading, at worst. The Fed’s rate increase in 2015 occurred in a much more uncertain environment. In our view, the market was attempting to understand the surprise currency devaluation by the Chinese and to gauge the impact of the ongoing collapse in crude oil prices.
We acknowledge that comments by various Fed officials this year have likely backed the FOMC into a corner. While the markets are currently assigning an approximate 50% probability for a December 2016 rate hike by the FOMC, we believe most investors sense a modest rate increase is a foregone conclusion. A rate hike, in our view, should be greeted with enthusiasm, as it suggests growing confidence by the Fed in the sustainability of US economic growth. More important, a rate increase this year would be implemented in a relatively more benign global economic backdrop. For example, it appears that China’s economy has stabilized. Further, oil prices have bounced from their February lows to a range that should facilitate rebalancing of supply and demand some time in 2017. The reversal in the flow of petrodollars associated with the collapse in crude oil prices appears also to have abated.
With respect to the US election, we have argued for some time that markets react to policies, not politics. Regardless of outcome, there will be sectors and asset classes that benefit and others that suffer. It is difficult to handicap relative performance with any degree of accuracy until actual policy proposals are offered for consideration. Moreover, given the necessity of a cooperative Congress to pass significant policy measures, the markets will be sensitive to much more than the outcome of the race for the Oval office. That said, our economy has undoubtedly suffered from the negativity associated with the lengthy election season. One of the disappointments this year has been the lack of consumer follow through of the windfall from low energy prices. We believe political rancor has damaged confidence both on the individual and the corporate levels.
During the most severe part of the equity correction during the First Quarter, we argued that economic fundamentals were sound and that the selloff was an opportunity for long term investors. We also felt strongly that conditions were similar to equity corrections in 1998 and 2011 and quite different from the collapse that occurred in 2008. Our analysis proved accurate.
The stock market’s performance since the First Quarter is most encouraging given its inauspicious start to the year. The market has broadened beyond defensive, yield-oriented sectors, which is another promising development. In fact, since June 30th, market leadership has shifted to more cyclical sectors, a possible indication that economic activity is accelerating.
We are constructive for the end of this year. It is highly likely that the election could contribute to heightened volatility, but we believe that a conclusion to this interminable election season could ultimately prove beneficial to the economy. The stock market will need validation of earnings growth to set new highs, but easier comparisons to 2015 should facilitate that process. Both Presidential candidates have argued for greater fiscal stimulus directed toward infrastructure spending. Such developments would prove positive for economic growth in 2017, but they would also have implications for interest rates and various asset classes. This year’s election could prove significant in a number of ways, not the least of which is the tenor of the Supreme Court. We urge everybody to remember that the constitutional right to vote is also a responsibility.