Q1 2015 Commentary

The market managed a small advance in the first quarter in the face of reduced expectations for near term real GDP growth and an anticipated decline in corporate profits in the quarter. With the market’s valuation no longer below average, this new set of expectations was able to impede the market’s progress and increase volatility. The revised expectations for real GDP growth in most recent quarter tend to fall in a range of 1% to 2%. Corporate profits are expected to fall by as much as 5% on a year-over-year basis.

Along with the downward revisions in real growth and corporate profits, the market was driven in part by significant declines in oil prices, Fed pronouncements, an increase in the value of the dollar relative to the currencies of major trading partners of the US and the unsettled nature of economic policies overseas. The net impact of these influences was to inhibit the market’s progress.

By the end of the first quarter, there was much speculation about the causes of the deviations in behavior of key variables from prevailing expectations. Thus far, investors appear unable to advance a coherent explanation for the shortfalls in growth and corporate profits. Consequently the outlook for profits and growth remained unclear and the stock market exhibited volatility as the second quarter began.

Unfortunately economic policies both in the US and overseas have not helped to dispel the uncertainties that weighed on the market. In the US the Fed was promising to reduce liquidity by raising interest rates at some point. The conditions which would warrant a rate increase were not made clear, and neither was the process whereby the Fed would raise rates. Historically, the Fed’s efforts to manage liquidity by managing interest rates have led to economic instability.
Proposed economic policies in the rest of the world have created a muddled outlook for growth overseas. Many governments appear to be grasping tightly to policies that have failed to promote economic growth in the past. The countries of the EU in particular exhibit an inability to develop economic policies capable of stimulating reasonable levels of economic growth.

The forecasts for real economic growth for the remainder of 2015 tend to fall in a range of 2% to 3%. With growth rates in this range, interest rates should drift upward, and the unemployment rate is likely to continue to decline gradually. Corporate profits are likely to show little or no gain in 2015 as a whole. Given the current valuation level for the stock market, if these expectations are realized, it will be difficult for the market to produce more than modest returns.