With the first quarter of 2016 now in the books, we reflect that movements in currency which then ripple through into commodities remain the major driver of market action. The vacillating tone of the U.S. Federal Reserve created some volatility. The Fed told us that rates would be heading higher over 2016 only to reverse course as the global economy continues to show an inability to get any real traction. That has caused the Bank of Japan and European Central Bank to be even more aggressive in their drive to lower interest rates and support economies and markets. The push downward on interest rates through the floor by these two major market players left investors wondering what the impact of negative interest rates would be.
Initially the shift has been from a rising U.S. dollar to a falling one as investors back away from expectations of the Fed interest rate hike. This drop led to a rally in commodity prices and related stocks, which was a key trend in the first quarter. Bolstering that trend was an easing of fears about a recession in the U.S., a change in tone that helped stocks shoot higher in March.
Chart 1: Falling U.S. dollar raises commodity-related sectors and markets
However, as the second quarter has begun, investors have poured money into the Japanese Yen despite the negative interest rate posture of the Bank of Japan. This flight to the safe asset of the Japanese Yen stands in stark contrast to the increasing “risk-on” posture evident in March. What’s behind this change in market theme only time will tell. Chart 2 below from Chris Kimble points out how a continuation of strong Yen – weak U.S. dollar could mark a change in trend.
Chart 2: Rise of the Yen could halt the upward move of stocks
Corporate profits are a headwind
Oh how we love this term “headwind” to describe anything and everything that presents challenge. It sounds rather benevolent does it not? Headwind. Anyhow, corporate earnings continue to be a drag on the stock market’s ability to mount a sustained rally. Will this quarter mark the worst of the profit slide? Only if oil prices can remain firm and energy company profitability bounce back.
Chart 3: Corporate profits falling due to energy company losses
Stock indexes slumped to begin the week with -0.3% coming off as oil prices dipped in Monday’s session. Tuesday opened poorly on the heels of market weakness in Japan and Europe. However, the selling did not accelerate as the day progressed leaving indexes holding roughly the loss they opened with. The -1.0% decline continued to work off the market’s overbought condition arising from 6-7 weeks of sharp rebound from the early February lows. The financial sector was weak on the day and sports a -7% decline year-to-date as the pace of expected interest rate hikes has slowed. A greater-than-expected drop in crude oil inventories fueled a rally in oil prices to support a Wednesday rally in stocks.
The +1% gain was further pushed by the release of minutes from the Fed’s most recent meeting, a report that confirmed expectations for a slow pace of rising rates. But overnight weakness in non-U.S. markets weighed splashed cold water on stocks once more ahead of Thursday’s trading session. European banks struggled with Germany’s Deutsche Bank (DB) approaching new lows for the year having erased entirely its recent four-week rebound effort. Markets pushed lower by -1.2%, a third consecutive +/-1% move after a plunge in market volatility of historic proportions over the prior six weeks. Friday ended the streak with a less choppy session which still found stocks struggling to gather any forward momentum. Strength in crude oil and overseas markets translated into only a +0.3% move higher in the U.S. as the market participants seemed disinterested in pushing up stock prices further until the first quarter earnings season begins.
Warm wishes and until next week.