Any investor, given the recent volatility and broad selloff, would be tempted to doubt the ability of the market to muster much more in the way of follow through, which is certainly understandable. There is palpable doubt in the market, and only a modest pull back in the measure of fear. Investors must keep several themes in mind when assessing the next directional move by US equity markets.
Will US corporate earnings/valuations and guidance support expectations of further revenue and earnings growth? Have we seen the worst of China's selloff? Has crude stumbled upon a tradable bottom? Will the EU be able to manage a move away from further ECB accommodation? Is the US economic activity likely to accelerate after a disappointing Q4 showing? Is the Federal Reserve likely to hold off on a move in rates next month?
Guidance Rattles Investors
From where I sit, several things are clear. US corporate results thus far have been in line with expectations, on the whole. It has been guidance that has unsettled investors. The lack of constructive forward looking guidance from the technology, financial and consumer discretionary sectors has led to a massive compression in valuations. That compression has led to some relatively cheap valuations in all three sectors. As far as Chinese equities are concerned, if we have not found a bottom, it is very likely we are not too far away from one given the downdraft that has been priced into equities. Will the EU's economy accelerate in the first half of 2016? I suspect there is no meaningful move away from current conditions - one way or the other. Effectively, the EU's economy remains economically hampered despite significantly cheaper equity valuations relative to the US.
Given the US economic data year-to-date, there is no clear sign that we will see a significant uptick in either activity or corporate earnings but given the sea of under-performance that surrounds us, that feeble growth may well be all investors need in order to justify an overweight in US equities. That relative attractiveness of US equities may well be enhanced by the Fed if in fact it does hold off on a move in rates in March - which I suspect will be the case.
Finally, crude oil; crude has clearly been range bound for nearly two weeks. Range bound is not synonymous with a bottom. However, we are significantly closer to a bottom now than we have been at any other time in nearly 18 months. Whether that bottom is found at $26/bbl or $22/bbl, we are likely within striking distance. In that case, the downdraft in equities fueled by energy will have at least abated.
In short, many of the variables that have led to the meltdown in pricing over the past several months appear to be abating. Valuations are more compelling than they have been in quite a while, crude is likely near a bottom as are Chinese/EM equity prices, and I believe it is likely that the Fed will leave rates unchanged in next month's meeting. I believe we have put in or are close to a short term bottom in US equities. Any significant trade below our recent lows will come as a result of an unexpected geopolitical event or the resurrection of previously mentioned variables in a dramatic fashion. In the event our recent lows hold, the likely trade moving forward is uneven, plodding and only modestly higher in the near term.
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