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Stocks started 2016 on pace for the worst beginning to a year ever, but then made one of the sharpest reversals on record on February 11th which ended up bringing the market all the way back to positive returns for the year. More intriguing was the fact that the worst quality stocks lead the recovery, with the beaten-up energy, materials and industrial stocks leading the advance. Emerging markets were also some of the biggest winners with the downtrodden Brazilian stock market leading the pack with a gain of over 20%. Pundits referred to the rally as ‘the dash for trash!’ Clearly investors had just gotten too bearish on the outlook for stocks and commodity prices. Once oil broke down below US$30, the consensus had it going to $20 in a hurry and even more investors piled into that short trade. The same situation occurred with stocks as bearish sentiment climbed higher at the same time as there was too much cash on the ‘sidelines’, waiting to buy on weakness. As we wrote in the title to our Market Comment last month, the ‘path of least resistance for stocks looks to be higher!’ But now stocks have rallied sharply, oil is back above US$40 per barrel, valuations are back to the top end of their recent range and investors are expecting the U.S. Federal Reserve to stay even more ‘dovish’ about interest rates than expected when they started raising rates in December. Moreover, the volatility of the stock market has dropped sharply, indicating lower levels of concern about the outlook.
The S&P500 has tracked its way back over 2050, which has been the top end of the trading range over the past two years. Will it once again be turned back from this upper bound or will stocks break through to new highs? Our view is that the upcoming first quarter earnings reports will be at the top of the list for market-moving factors in April as well as the ultimate determinant of the short term direction for stocks. (more…)