Capital Market Commentary – February 2016

February 18, 2016

By: Steve Clinton, President, Capital Market Securities, Inc.

We are now approaching seven years since the Great Recession. While the economic recovery has been slow, it has lasted much longer than a typical recovery. The average recovery, since the end of World War II, had been 58 months. The longest recovery on record was the 10-year period that spanned the 1990s. The length of the current recovery has been aided by the Fed’s maintenance of historically low interest rates. The Fed ended its “zero” rate posture and raised a key interest rate in December. This was the first increase in interest rates in almost a decade. How quickly the Fed is able to move interest rates higher will depend upon the continued strength of the economy.

Job creation continues to occur and unemployment has trended downward. Inflation remains in check. Business profitability may have reached a near-term plateau. Fourth-quarter earnings for the S&P 500 are expected to slide 5.3 percent, according to data provider FactSet. That would represent the third straight quarterly drop in profits, and the first time the S&P 500 has experienced such a decline since the first three quarters of 2009. Steady consumer spending has enabled the U.S. economy to continue to grow despite broad economic weakness globally.

As we enter 2016, there are a number of items worth monitoring:

  • Presidential Election – The Obama era enters its final year. The presidential campaigns have already begun in earnest. The primaries began February 1st. The future direction of the country will be decided in the next election.
  • Economic Growth – Last year, we predicted that “U.S. economic growth in 2015 will be hard-pressed to continue its strong pace.” Our prediction was correct in that the economy likely expanded 2 percent last year. The results reflect weak global trade and severe cutbacks by energy companies due to the slide in oil markets. Also, business investment has been limited. Our prediction for 2016 – a 2 percent growth comparable to 2015.
  • Housing – Home price values steadily accelerated throughout 2015, underscoring that the housing market is returning to normal as the economy improves. The S&P/Case-Shiller Home Price Index rose 5.2 percent in the 12 months ending in October. The index is up 36 percent from its low recorded in March 2012, and is only 11.5 percent below the high recorded in July 2006. We anticipate that real estate values will continue to increase at a moderate pace in 2016.
  • Oil Prices – In early 2015, we noted that oil prices had declined to $50 a barrel. Oil prices continued to decline in 2015 as supply outstripped demand. In early 2016, oil prices fell below $30 a barrel reaching a 12-year low. The prospect of up to 500,000 barrels a day of Iranian crude flooding an already oversupplied market is the main reason for oil price declines. We expect oil prices to fall to a level of around $25 a barrel and that will force major suppliers to restrict oil production which will drive oil prices higher in the second half of 2016.
  • Industrial Production – The industrial sector remains soft. Capacity utilization fell to 76.5 percent in December. Before the recession, capacity use typically hovered above 80 percent. U.S. car sales were a bright spot in 2015. Auto sales were a record, passing a total last reached 15 years ago as cheap gasoline, employment gains, and low interest rates spurred Americans to snap up new vehicles. In all, auto makers sold 17.5 million cars and light trucks in the U.S. last year, a 5.7 percent increase. We anticipate slowing auto sales in 2016. Rising rates will make auto financing more expensive.
  • Imports/Exports – Europe and Japan, the U.S.’s major trading partners are at risk economically. China’s problems have been well discussed in the press. However, U.S. exports account for only about 13 percent of gross domestic product. If the rest of the world falters, a relatively small share of U.S. production will be exporting into the weakness. We do expect the strong dollar and continued economic struggles of our trading partners to cause exports to trail 2015 levels.
  • Consumers – Consumer confidence is being tested as we enter 2016. For the six-year period beginning January 2009 until the end of 2014, the S&P 500 more than doubled. This increased wealth added to consumer confidence and consumer spending. In 2015, the S&P 500 was essentially flat for the year. 2016 has begun with a market correction of nearly 10 percent. It is likely the recent stock market results will weigh on household finances. Offsetting the negative of lowered net worth will be lower gas prices that will serve to increase consumers’ incomes. Overall, we anticipate consumer spending to hold steady.
  • Fed – We mentioned last year that we expected modest rising rates in the second half of 2015. We also predicted that the Fed would be patient. We only got one rate increase in 2015. With the state of the economy, we would expect the Fed to continue to move slowly in 2016 in its effort to move interest rates upward.

Market Update
The overall stock market ended lower in 2015. The U.S. stock market encountered its first correction (a drop of at least 10 percent) in four years in August. The Dow declined 2.23 percent in 2015 while the S&P 500 Index was down 0.73 percent. Short-term interest rates ended 2015 with the 3-month T-Bill at 0.16 percent. Longer-term interest rates increased modestly in 2015. The 10-year T-Note ended the year at 2.27 percent, compared to 2.17 percent at December 31, 2014.

Bank pricing followed the overall market decline in 2015. The KBW Bank Index declined 1.59 percent for the year. Bank prices, as measured by the KBW Bank Index, remain nearly 40 percent below the highs recorded in 2006.

Merger and Acquisition Activity
Merger activity in 2015 was comparable to the level of activity in 2014. Pricing on 2015 bank sales was comparable to 2014’s pricing, recording a median price to book multiple of 141 percent and a price to earnings multiple of 22.4 times.

Interesting Tidbits
As has been our custom from time to time, we like to pass along various items that we have seen that you might enjoy reading:

  • The number of Americans seeking first-time jobless benefits is lower this year than any since 1973. (Note: The labor force has nearly doubled since 1973.) This indicates that the number of workers involuntarily losing their jobs is trending near historical lows.
  • The U.S. bull market is now more than 6½ years old, the fourth longest on record.
  • JPMorgan Chase expects to spend about $500 million on cybersecurity in 2016. Bank of America Chairman Brian Moynihan has said that the bank’s cybersecurity budget is unlimited. John Stumpf, Chairman of Wells Fargo, said the bank spends “an ocean of money” on cybersecurity. Says Stumpf, “it’s the only expense where I ask if it’s enough.”
  • U.S. merchants are said to have paid $61 billion in interchange fees last year.
  • High-yield bond assets held by U.S. mutual funds total over $300 billion, triple their level in 2009.

Young & Associates, Inc. has a successful track record of working with our bank clients in the development and implementation of capital strategies. Through our affiliate, Capital Market Securities, Inc., we have assisted clients in a variety of capital market transactions. For more information on our capital market services, please contact Stephen Clinton at 1.800.376.8662 or click here to send an email.

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