Reasons for Continued Stock Market Volatility

The recent bounce in U.S. stocks has been welcomed after the tumultuous January and most of February 2016.  Does this mean that we will race back to the S&P 500 market high of last year?  Of course short term market forecasting can be a futile exercise, but our answer is no.  In fact, we believe that one should expect continued volatility in the equity markets in the near term.  Our rationale for our outlook is based on familiar themes such as China, the divergence of monetary policy between central banks, and the age of our current economic expansion.  However, there are fundamental reasons as well.  Our concerns were confirmed in a February 27, 2016 Financial Times article by John Authers titled, “Momentum matters as earning estimates go from bad to worse”.

Mr. Authers points out that the S&P 500 profits in the 4th quarter of 2015 experienced a 3.5 percent decline compared to the 4th quarter 2014.  In addition, earnings forecast have significantly missed the mark to the downside.  Tobias Levkovich of Citi is quoted as saying that U.S. long term earning expectations have fallen to a 50 year low.

The most concerning item in the article for me is the disparity between GAAP accounting numbers and adjusted numbers in company financials.  According to Thompson Reuters, the disparity is 28.6 percent.  This is approaching the disparity on the eve of the financial crisis.  The difference lies in how companies book expenses.  Adjusted numbers typically make the numbers more favorable.  For example, the article states that adjusted earnings for the S&P 500 stand at $110.74 per share. However, the GAAP earnings are $90.57 per share.

With these items in mind, the market looks expensive compared to the long term averages of past markets even after the volatility that we have experienced so far this year.   Prudence is definitely appropriate at this point in time.


Photo by kenteegardin

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