October 19


The world is flat…

is_the_world_flat_-_Google_SearchBy David Nelson, CFA

After nearly 10 months of investor mood swings often bordering on the psychotic, U.S. equity markets have been working their way back to the flat line. It was just a few weeks ago it looked like the correction would morph into a bear market or perhaps something even more sinister.

It wasn’t just stocks that went on a roller coaster ride. Treasuries, Tips, High Yield, Oil, Gold, Emerging Markets etc. all had big swings from euphoria to despair and back again. A reversion to the mean seems to be the prevailing theme as many asset classes fight their way back to where they started the year. Not all will complete the journey but enough to make the point.


A performance chart of popular ETF’s shows the price action year to date. Biotech still leads the parade but even here we can see how much IBB has retraced since mid-year. The biggest drag on traditional balanced accounts has of course been international stocks but even here we see strong progress off the bottom.


Volatility has made a round trip as well. The VIX sits pretty close to where we started the year despite a push to over 50 just a few weeks ago.


What does all this mean? 

At least for now, markets are choosing to look through obvious headwinds to what is perceived as better days ahead in 2016.

There’s been no shortage of concerns this year with China, the Fed, Dollar and Oil all contributing to investor angst. Third quarter earnings aren’t likely to be much help as many companies continue to struggle with organic growth.


One look at the recent graphic from Goldman’s research team shows while we are getting positive earnings surprises albeit on lowered expectations, the top line is disappointing.


I’m going to go back to what I discussed just a couple of weeks ago. Oil and the Dollar both of which have been stabilizing are key for the rest of this year and beyond.

The importance of stable energy prices can’t be overstated. Not only will it take pressure off the high yield debt market but as we head into 2016 year on year inflation numbers won’t face the added drag of plummeting crude. Last year’s article Oil and the Black Swan showed the strong relationship and dependency of the oil patch with high yield debt.

The good news 

If oil can stabilize, some challenged companies will be able to roll over debt coming due this year. Not only is this good news for the sector but also for banks and creditors at risk.


As for the dollar every economist and analyst understands that a rising dollar makes it tougher for U.S. multi-nationals to compete. The charts show at least year to date both oil and the dollar have been in a range. If these levels can hold then the 10% earnings growth imbedded in current estimates for 2016 is achievable.

It’s still early in the season so the next couple of weeks will be dominated by Q3 earnings reports. Don’t react just off the headline numbers. Get on the conference calls or at least read the transcripts before pulling the trigger. In most cases management commentary and guidance will be more important than the actual release.