After celebrating the new year by plunging over ten percent in less than three weeks, U.S. stocks have rallied sharply. At this writing, the S&P 500 Index is almost back to even for the year. Does the recovery in share prices suggest smooth sailing ahead, or is the volatility that has plagued the market since last August likely to return?
As long-term investors we don’t put too much weight on short-term forecasts but our guess is that we haven’t seen the last of the volatility. So far this year stocks have been trading more or less in lockstep with the price of oil. Brent crude began the year at a bit over $37 a barrel, dropped over 20% to $28 or so, and has since rallied to around $41. The rally is predicated on a tentative agreement between Saudi Arabia, Russia, Qatar and Venezuela to limit production. While it’s possible that the pact will hold and keep prices over $40 a barrel, it’s far from clear that these producers will be able to agree on sufficiently large cuts to get the job done. It may be that the price of oil will only stabilize when many more shale oil producers in the U.S. go bankrupt. And the recent spike to over $40 a barrel may actually slow that process down.
The other issue worrying capital markets since last summer is how Chinese authorities are handling problems with their stock market, currency and overall economy. Without getting into the details, suffice it to say that while we don’t expect a “hard landing” in China, we also don’t believe any of the underlying issues have been resolved.
The one bit of good news over the last few weeks is that economic data in the U.S. has picked up a bit and fears of an imminent recession have, appropriately, receded. Still, we wouldn’t be surprised if somewhere in the coming weeks China and/or oil once again create significant stock market volatility. Fortunately, the flip side of volatility is buying opportunities. Large share price declines are often indiscriminate, leaving certain sectors and certain companies trading at especially attractive prices. We’ve already taken advantage of some of these opportunities for client portfolios and expect that we, and our managers, will do more of the same as the year unfolds.