Stocks surged on Friday, with the S&P 500 rising 2.5% to end the week and the month on a positive note. Of course, while the last two weeks have seen advances, the first two weeks of January witnessed substantial declines. It was, to be sure, a volatile month. All in all, the S&P 500 declined 5% in January.
At this point, investors may well ask: what caused the recent two-week rally? Will the rally last? And, perhaps most importantly, what does a down January mean for the rest of the year?
What caused the recent rally?
As to what caused the recent rally, a major factor was the sharp rebound in the price of oil. After hitting a 12-year low ($26.55 per barrel) on January 20th, U.S. crude oil prices steadily rose to close the month at $33.62 a barrel. This rise was driven by news that Russia and Saudi Arabia (and OPEC) might cooperate to reduce the worldwide supply of oil. Such production cuts, if forthcoming, would likely result in higher oil prices (which the market now wants). Apart from oil, the stock market rally resulted from central bank policy decisions and statements over the past two weeks. First it was the European Central Bank (ECB) president implying that additional monetary stimulus would be forthcoming in March to help support European economic growth. Next it was our own Federal Reserve issuing what was perceived as quite dovish comments, reducing (but not eliminating) the possibility of a March interest rate increase in the U.S. And last, but certainly not least, was the surprise move by the Bank of Japan (BOJ) to adopt negative short-term interest rates, in yet a further effort to stimulate the Japanese economy.
Will this rally last?
Only time will tell. It would be prudent, however, to be a bit skeptical. The Bank of Japan’s decision to move to negative interest rates could spur China to further devalue its currency, a move that would likely roil equity markets, at least temporarily. Further, added stimulus by the BOJ and the expected added stimulus from the ECB may well result in a new round of U.S. dollar strength, which likely would be a negative for the S&P 500. Also telling, is the fact that defensive sectors such as utilities, telecommunications, and consumer staples were among the S&P 500 leaders last week. And the yield on the 10-year U.S. Treasury note fell below 2% to 1.93% at week’s end, another sign of risk aversion. Gold also rose.
What does a down January mean?
The big question, though, is what does a down January mean for the rest of 2016? About this time last year, I wrote a commentary called “Is a Down January So Bad?” The S&P 500 had finished January 2015 down 3.1% and I then observed that “market history … favors a positive close to this year , despite the negative January.” In fact, the S&P 500 did finish 2015 up 1.4% on a total return basis. In 2014, the S&P 500 likewise finished January down 3.6% only to close the year up substantially, over 11%. Will it be the same in 2016? I must admit to greater uncertainty this year than I had last year. Nonetheless, it is a fact that, since 2000, we have seen more negative (10) than positive (7) January performances and yet, in a majority of these years, the market turned around and ended the year up. Potentially instructive is 2009 when the S&P 500 closed January down over 8% (a good bit worse than 2016) yet finished the year with a gain of 24%. Clearly 2009 was different in that the U.S. economy was just coming out of a severe recession and bear market, but so long as the U.S. economy remains out of recession in 2016 (which is our base case), market history suggests that we will see higher equity prices by year end, and even positive overall returns again.
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