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Nature versus Nurture

From time to time, history seems to repeat itself. Similar to the calendar year 2015, the first quarter of 2016 for equities was home to a wide trading range, yet equity markets finished little changed at quarter-end. From the start, equity markets turned south into negative territory, and continued downward nearly unabated until February 11th. That date marked a low for the quarter—equating to an S&P 500 move of over 10% down from January 1st. Just a month and a half later, the S&P 500 closed slightly positive for Q1 in what by some measures marked the largest first quarter reversal since 1933. In a matter of three months, equity markets experienced both the worst start of the year ever, and one of the largest reversals. How’s that for volatility?

NatureVsNutureGraph

Although the year is only three months old, it is clear that both Energy and the Federal Reserve have been the two biggest forces in the market. Both are acting as resistance for capital markets, and in maybe not such a strange coincidence, both the S&P 500 and oil saw their lows for the year on February 11th. Since then, oil has risen 50% off the lows in tandem with the U.S. Federal Reserve committing to a more dovish stance, and reducing the likelihood that the U.S. might experience four rate hikes in 2016. Coupled with other global central banks also either adding to quantitative easing and/or lowering interest rates, the global backdrop of “easy money” continues to be the law of the land. 2016 has also given rise to a new acronym in the financial community; NIRP. In several areas worldwide (e.g., Japan, Europe, Switzerland), Zero Interest Rate Policy has given way to Negative Interest Rate Policy, or “NIRP” for short.

This brings us to the title of this piece—“Nature versus Nurture”. The current bull market turned eighty-five months old at quarter-end, marking a cumulative return on the S&P 500 of 204% since March 9, 2009. A significant run considering that since 1928, the average bull market has ended after just fifty seven months with an average increase of 165%. One, if not THE, question weighing on investors’ minds, is whether the stock market can continue on its historic run, or whether it will fall victim to a sustained decline. Many of the naysayers of the stock market’s performance will argue that stocks are only where they are because of the “nurturing” of the Federal Reserve (and other global central banks) engaging in quantitative easing and injecting significant levels of liquidity into the monetary system. This additional liquidity searches for a home – a home like a corporation’s stock or government bonds where an absolute positive return can be had, thus pushing equity prices higher and driving bond yields lower. Said another way, capital seeks return, and there are currently limited options for investors to have a shot at earning a positive real rate of return. Given all the quantitative easing that occurred in tandem with a healthy positive return in both the stock and bond markets, the naysayers may have a valid argument… or do they?

The other side of the argument is that the stock market has continued to rise, not because of quantitative easing or financial repression, but because companies are back to selling products and services, making profits, and organically growing their business. S&P 500 profits are still positive, and after removing the energy sector and the outright recession it is currently going through, the data is even more attractive. Our country’s labor force is increasing, meaning more individuals are actively seeking work, yet the unemployment rate continues to decline. This suggests a healthy labor market, which can be further confirmed by an increase in average hourly earnings (i.e., wage growth) that may be priming the consumption pump to further drive our country’s economic cycle. We have suggested on several occasions that the consumer was the missing ingredient to our current economic recovery. With low inflation, less expensive gasoline prices and an increasing wage environment, it could be this is the current “nature” of our economy, and we are instead in the early stages of a rarely experienced extended economic recovery.

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David M. Kirkpatrick, CFP®
SVP, Portfolio Manager

Charles A. Williams, CFP®,CTFA®
SVP, Portfolio Manager

Brian A. Barker, CFP®, AIF®
SVP, Director of Asset Management