Pennsylvania Trust

Leaping Ahead

Leaping Ahead

Photo of George McFarland.Last week began with a “Leap Day” (February 29th). As if on cue, the major domestic equity indices responded by jumping over 2% higher for the week, marking their third consecutive weekly advance. Having now risen in five of the first nine weeks of the year, U.S. stocks appear to be regaining their traction, with the S&P 500 down “just” 2% for the year through March 4th.

As we have done in the past, let’s stop and ask what has produced this recent rally? And, more importantly, is the rally sustainable?

What has caused the recent rally?

Not surprisingly, the same three factors – oil, the Fed, and China – that led the markets lower earlier in the year have played an important role in the recent rally off the markets’ mid-February lows. Oil, for example, has risen from around $25 per barrel to over $35 per barrel. Other commodities, such as copper and iron ore, also have rallied higher as the U.S. dollar has fallen. Investor sentiment undeniably has risen along with commodity prices, as fears of an imminent recession fade.

One positive result of the mid-February market turmoil was that the markets began to discount the odds of any Federal Reserve rate hike during 2016, and particularly during the first half of the year. Having worried that repeated interest rate increases would represent a Fed policy mistake that could propel the U.S. economy toward recession, investors took comfort in the prospect of an extended Federal Reserve pause.

China, too, played a role in the recent rally. Here it was the absence of any bad news that was taken as a positive. With no additional headline-grabbing currency devaluations to contend with, and instead fueled with a rebounding Chinese stock market, investors pushed U.S. stocks higher.

Is the rally sustainable?

The real question, of course, is whether this almost 10% advance off the mid-February lows is a bear market rally or the initial steps toward a resumption of the bull market. While no one really knows, odds favor that this current rally will end sometime over the next several weeks and will be replaced by a sideways, range-bound market—or perhaps, at least one more move down.

Signs abound of continued market choppiness ahead. Safe-haven assets, such as gold, have risen even while the stock markets have risen. U.S. Treasury bonds remain in strong demand. Defensive stocks, such as those in the consumer staples and utility sectors, continue to show strength. Investors, to be sure, remain wary.

Near-term prospects for the equity markets will continue to revolve around oil, the Fed, and China. If oil stabilizes above $30 per barrel, if the Federal Reserve holds rates steady later in March, and if China continues with no negative surprises, then the markets should be able to consolidate recent gains and grind higher. However, should oil resume its slide back into the $20-$30 range, should the Federal Reserve surprise the market with a rate increase, or should China disappoint, then we should brace ourselves for another likely move lower. That said, equities remain the asset of choice for the longer term—as much as the markets can change over the short term, that fact has remained constant.

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