The market sold off in the first few weeks of January, spooked by the new year’s hit to the normally volatile Chinese stock market and compounded by anxiety over the quarterly earnings reports and outlooks. Early in the month fears affected nearly every sector: technology, energy, financials, industrial, and health care. During the first three weeks, the S&P sold off 7%, for the worst start to the new year on record.

In all the nervousness, first quarter 2016 earnings estimates for the S&P 500 were reduced by nearly 5%, to $27.76 from $29.14 per share.* Now with 40% of the companies in the S&P having already reported last quarter’s earnings:

• over 70% reported better than estimated earnings
• nearly 10% reported in line with expectations.

While it’s still early in the year, we expect to see estimates increase again in the coming weeks and months.

Meanwhile the Chinese economy continues to grow at a rate of nearly 7%.** This growth has been in a gradual decline and reflects a change in government direction from an industrial-oriented economy toward a consumer service-driven economy. This is a slowdown from over the 9% growth rate of a few years ago. However, the growth rate reported in January for the prior quarter was still within most economists’ expected range, and does not warrant additional concerns at this juncture. As we’ve pointed out in the past, China represents just 2% of our total exports.

Given the market correction both here and abroad, however, it certainly presents many opportunities. Specifically, we believe the stocks of large cap, multinational companies with strong balance sheets that offer good dividend yields and have the capacity to continue to grow dividends at a rate faster than inflation have been hard hit in January and offer tremendous value currently. These are the types of stocks that we own in the Gradient 50 portfolio.

Looking at US stock valuations, they were pushed down from 16.1 times forward twelve months earnings at the end of December to just 15.2 times currently. This compares to 17.2 times last February. See the chart below.

We believe this new, lower valuation is very attractive for new money coming into the market, particularly given modest estimates for earnings growth of just 5% in 2016.

Annual earnings growth is just one metric. The pace or cadence of growth is also important, that is, whether earnings growth is accelerating or decelerating. We believe it’s accelerating. Look at the consensus outlook for earnings growth in the next several quarters as provided by FactSet in the chart below.

Earnings estimates for the coming year reflect a widespread view that the headwinds to earnings growth in 2015 (namely falling oil prices and the strength in the US dollar) will fade and become tailwinds to growth in 2016. With our outlook for an accelerating rate of growth in the coming quarters, we believe current valuations have overly discounted this scenario.

Companies in the Gradient 50 portfolio, with their exposure to international sales and energy, should benefit from these tailwinds. With large capitalization stock prices down 6% on average for the month of January, we believe now is an opportune time to add to your holdings for dividend income and potential capital gains.

Sources: * FactSet 1/29/2016
** Reuters 1/19/2016

Last year left many investors frustrated. This year, frustration may turn to desperation. Fortunately, one month does not make a year. Just two years ago the stock markets began the year with similar price action. In January 2014 the S & P 500, the Dow Jones Industrial Average and the MSCI Emerging markets were down 3.6, 5.2 and 6.5 percent respectively. These indices finished that year at +13.7, +10.0 and -2.2 percent. This year started on a similar sour note as the same three indices declined 5.0, 5.4 and 6.5 percent in January. Where we finish 2016 is anyone’s guess at this early stage.

The January global market correction was rooted in news from China and the oil industry. The Chinese economy may be slowing at a faster rate than advertised and their U.S. linked currency is being aggressively devalued. This, plus oil prices reaching 13-year lows, stressed stocks, high yield bonds and commodity prices around the globe. January provided a gut check for even the most seasoned investors. There were few places to hide as even the darlings of 2015 were taken down.

One of my favorite Seinfeld episodes is where George comes to the realization that everything he does is wrong, so he commits to doing the exact opposite of his initial thought. George follows his own advice and everything turns to gold for him. Such is the struggle of the average investor. When the markets melt down, like it did in January, the initial reaction is to sell everything and go to cash. Unfortunately the opposite is usually the better answer. Buy low and sell high seems so simple until we allow emotions to decide our next action. When you feel close to veering off course, think opposite.

Thankfully, not everything was down. When stocks suffer investors usually flock to safety. This month was no exception as long U.S. Treasuries and gold were sought for their safe haven qualities. Yields on the 10 and 30-year U.S. Treasuries declined 33 and 26 basis points during the month sending their prices substantially higher. Even gold found a bid as prices rose by 4.8 percent for the month.

The bond market this year may act a lot like the bond market last year. Once again, everyone is expecting higher rates and multiple Fed tightening moves. The Fed believes they will hike the fed funds rate four times at one-quarter point each time. More likely will be the Fed monitoring data in the first half of the year and making one, possibly two twenty five basis point hikes in the second half. The yield on the ten-year Treasury may stay in the 2.0-2.5 percent range until real global economic growth emerges. Bonds are likely to be a boring asset class with low single digit returns. After this past month, a little boring might be just the right prescription for your portfolio.

Don’t expect miracles in 2016. Also do not expect eleven more months like January. The market will take a pause from the China and oil news to focus on fourth quarter corporate earnings. This may well be the catalyst for a much needed price reversal. U.S. stocks will face lighter headwinds in 2016. Stocks will benefit from continued low global interest rates, an eventual bottoming of oil prices, moderation of dollar strength, resilient consumers, and favorable earnings comparisons in the quarters ahead. Remember the goal is to buy low and sell high and resist the emotional pressure to sell low when times are tough. Investing is a marathon, not a sprint. Stay patient and invest for the long haul.

MARKETS BY NUMBERS:

Last week the S&P 500 had a positive week for the first time this year. The first two weeks were down significantly. Investors are concerned with the following issues:

Of all these issues the price of oil seems to be the biggest driver of the investment markets right now. In fact the correlation of oil price moves to investment market moves has risen to all-time highs. See the chart below highlighting this effect. The chart on the left shows correlations to oil during the last 12 months and the chart on the right shows correlations the last 10 years:

What’s interesting is that U.S. stocks used to be negatively correlated to oil where now they are highly correlated to oil. And High Yield has moved from a small correlation to over an 80% correlation to oil price movements. Lower oil prices used to be considered a good thing for the economy, but not so much today, why?

Because of this, the decline in oil from $37 to $27 the first two weeks of January led to stocks declining sharply, and the subsequent recovery in oil this past week from $27 to $32 led to a nice rebound in stocks. It appears for the time being oil prices will be at the forefront of investor sentiment and we’ll be watching it closely.

As oil price movements become more volatile, we’d expect the stock market to become more volatile. This has been the case as the VIX chart below illustrates:

The VIX is an indicator of market volatility and we can see that recently volatility has increased (red circles) above relatively lower levels of volatility (red line) we’ve experienced the last 2 years. One thing to keep in mind:

We are keeping a close eye on both the stock and oil markets. Market volatility has picked up, but we still believe our forecast of positive mid-single- digit returns is achievable.