February 22, 2016

While Jim is away on vacation, other members of the TBA Investment Committee will write the market comment.  Today’s comment is from Maris Ogg.

If you had any doubt that we are living in a global economy, recent softness in the U.S. should dispel the question.  The U.S. economy is still chugging along at about a 2% rate of growth, but a “China wind chill factor” makes it feel like we’re sliding backwards.  It does not help that we have entered a Presidential election year because candidates are relentlessly telling us how terrible things are.  We have been positing for over a year now, that the world is awash in everything from commodities and oil to labor and money.  Most of these excesses have a more negative impact on emerging economies than on the U.S., but we’re feeling the shock waves, too.  Many companies and countries expanded their capacity to produce commodities demanded by Asia, especially China.  When China’s growth receded, the world was left with excess capacity.  Monetary authorities across the world acted quickly to stimulate when the 2008 recession began, but they have been slow to reverse the stimulus, creating excess liquidity across the world.  What we are describing is the symptom of a good, old-fashioned inventory correction – a global inventory correction.  We thought sophisticated accounting systems like Oracle and SAP eliminated excess inventory accumulation risk, as companies can analyze their inventory positions in real time and make corrections before stocks overwhelm demand.  However, global excess is impossible to predict and difficult to track, making the duration of the current slump unknown.

After three up days in a row and a rebound of almost 1000 points on the Dow, Friday’s oil price slump sent investors back into pause mode as they try to get a handle on the odds of oil (and other commodity) prices stabilizing.  Markets are also evaluating whether Q4’s disappointing earnings season spills over into Q1 of 2016.  Nordstrom’s poor report late Thursday sent most retail stocks down again on Friday, and yet recent retail survey data suggests that sales recovered a bit on President’s day weekend.  Everyone seems to love a good sale!  And importantly, the faster prices drop, the more quickly inventory clears, both for oil, other commodities and excess apparel inventory.  Same for stocks, which brings us back to the long term.  Recognizing that lower commodity prices are positive for consumers and that consumer spending accounts for about 70% of our economy, helps put the current decline into perspective.  Couple that with the continuing strong employment numbers which has resulted in rising average hourly earnings, and the odds are increasing that consumer confidence will continue to build and consumer spending will continue to drive growth.  The flip side of course is that higher wages and lower prices hurt corporate margins.  Fortunately, companies have been able to cope with this pressure over time and we are confident that they will find a way to restore margins.

So, absent a negative geopolitical event or some kind of deeper economic downturn in China or Japan than currently seems likely, the stock market is probably well into the process of discounting the current sluggish environment and the global inventory correction is probably beyond the halfway point.  We believe that the current market correction will be complete sometime before year end.  Currently, the market multiple of about 16X earnings is right at the long term average.  While that leaves us in “fairly valued” territory, the market’s volatility periodically gives us opportunities to buy stocks that seem to have been unreasonably punished by short term concerns.  Make your shopping list and don’t hesitate when the price is right.

Maris A. Ogg, CFA 610-260-2216

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