A remarkable downdraft in stock prices marked the first quarter of 2016 and was followed by a robust recovery. This V-shaped movement is not unusual in presidential election years. There is great uncertainty about the political outcome at the start of such a movement. The premium attached to stock prices begins to dissipate when that uncertainty is resolved as the political field narrows. We have seen that pattern play out in this remarkable, entertaining presidential election year.
Added to this volatility is the divergence in interest rates between negative and positive interest-rate policy. The United States is the leader in the positive interest-rate policy camp. The European Central Bank has now been joined by Japan as large players in the negative interest-rate policy camp. Policy divergences, which were prominent throughout the quarter, amplify the volatility of stock prices in both directions.
Tepid Recovery
Meanwhile, the US economy continues its tepid, low-inflationary recovery. The US is not in a recession. Instead, it continues to grow at a very slow pace. Sluggish growth means that inflation and interest rates will stay low as long as the Federal Reserve (Fed) does not act precipitously. Indications are that the Fed will move once or twice in 2016.
As we expected, the original forecasts and warnings of four rate hikes in 2016 have fallen by the wayside. We published commentaries months ago regarding our own forecasts. “Divergences,” published by yours truly on January 21, 2016 and “,” published by my colleague Bob Eisenbeis on January 8, 2016; these provide some detail on those forecasts.
Two Moves or Four? At Cumberland Advisors, we think very low interest rates create an upward bias in asset prices. That positive bias includes the US stock market prices represented by the exchange-traded funds we select for positioning in our US portfolios.
David R. Kotok, Chairman and Chief Investment Officer