GDP
From a growth standpoint, GDP isn't doing so hot. Q4 2015 growth is estimated at a meager 0.7% - certainly not very strong. Perplexingly, though, unemployment is at record lows - just 4.9%.
So what's going on here? How do we have more and more people at work but remain below trend GDP? To find the answer, we've got to do a bit of simple math.
You might recall this equation: GDP is the output of people at work multiplied by (drumroll please)
productivity.
Aha! There's our culprit.
If employment is up but GDP is still down, it must mean that productivity is lagging. (In fact, in February GDP was an astonishing -0.3%.) I've mentioned it before, but the root cause is a structural problem: as our economy changes, we're challenged to have enough qualified people in the most productive positions. There's not an overnight fix, unfortunately - we'll need long-term training and education that better aligns with the direction of our economy.
Now, this isn't a crusher right now, but it does mean it's going to be quite important that as a country we don't drop the ball in this area. As our workforce ages and demographics change, this problem will only increase. So it's possible that we'll see some economic slowing as we realign the labor force.
Treasury yields
If you've been keeping up with my newsletter (thanks!), you'll remember that last time I mentioned the ten year treasury yield being
lower than it was before rates were raised by the Fed. Well, what do you know - the yield is even lower, a tiny 1.75%. This indicates even further slowing in the economy and a general flight to safer assets by investors.
Our economy is built, to a degree, on our willingness to take risk. This low yield we're seeing is a big flag pointing to a very risk-averse mindset.
China
If you don't believe it yet, you soon will - China is slowing and they've even indicated that growth will likely stagnate around 6.5% annually from here on out.
From my own work and conversations with a few analysts, I'm expecting that number is actually a bit high. Some of their monetary policies are "tightening" rather than being more accommodating, and while I'm not predicting an imminent recession, I still think 6.5% is a stretch. (Good luck getting them to admit that, though!)
Oil
As you well know, oil prices are lower than they've been in years. While you might be smiling at the pump, there's another side to the story.
I
f oil continues selling at these rock bottom levels, many oil companies are going to struggle. We've already seen them (and related companies in their space) cut dividends. Don't be startled by some bankruptcies on the horizon, too.
Due to the capital-intensive nature of these companies, most are saddled with heavy debt. Bankruptcies would mean defaults on their loans, ultimately hurting the financial institutions and causing a bit more stress all around.
Don't lose sleep over it, though (unless you own an oil company). Historically, we've seen this happen before and it just takes time to work out.
Fiscal policy
As I'm writing this, I'm sneaking peeks at the testimony of Janet Yellen before Congress. We've all had our fill making the Fed our punching bag for positions on price, but I think it's important to understand the limits of their mandate: employment and price stability.
In a nutshell, our system is a dance between Monetary policy (the Fed) and Fiscal policy (Congress). And right now, unfortunately, I think the only one dancing (and working) is the Fed.
If the questions I'm hearing from Congress are any indication, I'm questioning if they understand the basic role and limit of the Fed or even their own heavy responsibility in economic growth. The Fed can only do so much, and without the right Fiscal policy we'll continue to get poor allocation of capital.
Many times, the two parties have come together to solve issues like this. But considering the double whammy of a Presidential election year and a year when it's in vogue to hate the banks more than your opponent, I think compromise is still a long way off. This means more temporary baloney (to put things nicely).
Micro Fundamental
For some, this earnings season has looked more upbeat than expected. Note the following, though: (via FactSet)
Earnings in Aggregate: So far, the blended earnings decline (actual and estimated earnings) is -3.8%. If this remains it will be the first time the index has seen three quarters of year over year decline since Q1 2009.
Earnings Guidance: For Q1 2016, 57 companies have issued negative EPS guidance and 14 have issued positive guidance.
Valuation: Using earnings estimates for the S&P 500 of $124 for the year, we are trading at a Forward Price Earnings ratio of 15.08 (using yesterday's S&P 500 close of 1870). This is higher than the 10 year P/E average of 14.2 times forward earnings for the index.
To me, this means we're close to a reasonable pricing level. Then again, I'm discounting all of the people screaming that we're "cheap" here.
If we take the multiple of 14.2 and use the given $124 in earnings we get an S&P 500 level of 1760. Now, one of the more positive possibilities is that - because interest rates are so low - we might be able to live with higher Price Earnings multiples and we don't need to come down after all.
The bottom line will be how earnings come in over the course of the year and that's what I'll be watching. For right now, though, I'm in wait-and-see mode relative to those earnings. My belief is that we'll see a year-over-year decline in earnings for the first quarter (and maybe the second quarter) of this year before we see an acceleration.
The Technical Picture
These days, we tend to think of a "bear market" as though it were some fantasy event that happens only when pigs (or bears) fly.
To be truthful, a bear market - as denoted by a 20% or more drop in the indexes - has happened 25 times since 1928 (about once every 3+ years). The length of these markets has run between 1.9 months to 21 months and the median downturn has been approximately 33% (BoA/Merrill Lynch Global Research).
I know the market feels scary right now, but we've seen this before. The question lies in how we handle it. I'll get into this shortly, but first let me show you what I see in the charts.
Russell 2000:
The Russell 2000 is an index of stocks that usually better illustrate the plight of smaller and medium sized companies when compared with the Dow and the S&P 500.
Take a look - we've actually entered a bear market for this index.
