Some time ago, during a typical winter day in upstate New York, my dad and I were traveling west on the thruway when we were engulfed in a whiteout near Syracuse. It was snowing and blowing so hard our visibility was zero, even the hood of the car was obscured by the blinding snow. We had no choice but to continue on, hoping to eventually drive out of the blizzard. So on we drove, with me at the wheel, looking out the driver’s side window for the guard rails on the left and my dad doing the same on the passenger’s side. It was useless to look straight ahead. We eventually made it, but it was not something I would ever like to repeat.
Predicting the market thus far in 2016 seems a bit like a winter whiteout experience. The fate of the market this year largely rests on three macro forces, each difficult to predict. First, the U.S. economy, which has been weakened by the strength of the dollar and also by the slowdown in China, is inching closer to a potential recession. The Fed, which not long ago talked about raising rates steadily during the year, may now be on hold for a while longer. Corporate profits have been reasonable, but most companies have tempered forecasts for the remainder of the year, and virtually no companies are showing greater than expected revenue growth. Whether the overall economy avoids a recession is a tough call at the moment.
Second, with so much at stake politically, the fate of the presidential election remains difficult to predict. Various industries, as well as the general business climate, will be greatly impacted by election results. With visibility limited, corporations are cautious, exacerbating the slow-growth environment. This uncertainty is likely to hang over the markets until Election Day.
Third, the precipitous decline in oil prices, and the U.S. withdrawal from world political leadership, has resulted in increased geopolitical risk in various areas of the world. This increased potential for a disruptive exogenous shock has corporations and investors understandably cautious.
In certain market environments the prudent strategy is to focus on company and industry fundamentals, and worry less about macro issues that are impossible to predict. This doesn’t mean these major issues should be ignored, but too much time spent trying to predict events that are largely unpredictable, can paralyze investment decision making. This may be one of those times.
Given this uncertainty, we feel it will be increasingly important to focus on industry-leading companies which are strengthening their competitive advantages over their peer group. In this regard, we will play less attention to short-term fluctuations, but instead concentrate on sustainable trends, including relative earnings growth, new product innovation, and operational efficiency. In most cases stock performance will reflect management’s commitment to enhancing shareholder value despite the challenging economy.
On the positive side, 2016 could be a potential record year for mergers & acquisition activity. With still solid corporate cash flow and the anti-competitive U.S. corporate tax rates, we expect M&A activity to continue to gain momentum. Generally speaking this should have a positive effect on stock prices.
There is no denying that 2016 could be an extraordinary year that charts the course for our country and markets for many years to come. Prudent investment strategy will require adaptability as well as discipline. A diversified portfolio balancing growth, income, and risk management should weather whatever storm arrives, however long it lasts.