In January and early February there were three major negative forces affecting the market. One was the total collapse of oil prices down to $26 a barrel. The second was a very real threat of a big devaluation from China. The third was the Fed hiking interest rates four times in 2016!
Those three deflationary forces would be very negative for stock market returns around the world. Six weeks ago, investors believed that the world was coming to an end. Some market experts were even taking about an increased possibility of the U.S. economy falling into a recession.
Why some market bears are getting bullish?
- The turnaround in the price of oil has been dramatic, raising almost 50% in six short weeks. Fears of massive credit defaults in the oil patch has been greatly reduced. Therefore, worries of a banking crisis have decreased and prices of bank stocks have recovered along with some energy names.
- Currency speculators and U.S. hedge funds have been heavily shorting the Chinese Yuan believing that devaluation is just a matter of time. China’s battle with speculators is expected to be very prolonged. Chinese leaders have assured Washington that it would keep the yuan stable after the U.S. approved adding the yuan to the International Monetary Fund’s basket of reserve currencies.
- The Federal Reserve has decided to halve its outlook for interest hikes to two from four by the end of this year. The announced has weaken the value of the U.S. dollar which helps increase the price of commodities including cruel oil. It also weakens the value of the yuan since 60% of its value is pegged to the U.S. dollar.
The chart below illustrates the price movements of the bank and energy ETFs compared to the S&P 500 since Feb 11 when the price of WTI hit a low of $26.19!
I am not convinced that we are out of the woods yet
- Iran is a big wild card in the oil market. Iran has already stated that they will not agree to a production freeze until they increase their production back to levels before sanctions were imposed. Iran wants to add two million barrels of cruel oil a day to an already over supplied market. Plus there is over 500 million barrels of oil still in storage.
- The Chinese leaders are slowly realizing that they have little control on how their citizens spend their new-found wealth. Converting their economy from being export driven to domestic spending is going to take a long time.
- Negative interest rates in both Europe and Japan have not been successful in boosting economic growth.
- U.S. consumers are not spending their savings from lower energy costs. Economy growth after a typical recession is usually a lot higher than today.
- A large part of the rapid rebound in stock prices could be due to short covering by hedge funds.
I am not an expert on charts but the two-year chart below of the S&P 500 appears to have lower highs and lower lows. Plus I don’t like the fact that the 50 day moving average is below the 200 day moving average.
I believe that the roller coaster ride isn’t over yet and there could be a better buying opportunity very soon. Long term, I still prefer stocks over bonds.