FOCAL POINT MANAGEMENT

Investment Advisory & Wealth Management Services

Winter 2016 Update

Slip Slidin Away

Key Points
The sharp market sell-off so far in 2016 has triggered fears of a pending U.S.
recession, but such concerns are overwrought.
Fundamental conditions remain relatively solid outside of slowing Chinese
growth and the collapse in oil prices.
Double digit market declines are to be expected, they have occurred 2 out
every 3 years, and can and do occur during periods of economic growth.
It will likely take some time, but investor sentiment should recover over the
coming months.
Happy New Year!? The markets are off to a rip-roaring start this year -- in the wrong
direction. Few investors were sorry to see 2015 go, with its stomach-churning moves
ultimately ending up with major indices experiencing losses for the first time in 7 years,
but the start to 2016 has been decidedly worse. Marked by multiple triple-digit down
days on the Dow during the first several weeks of trading , the apparent catalysts for the
sellinggeopolitical and Chinese growth fearshavent greatly altered the overall
picture to any great degree. Mixed economic data, a renewed collapse in oil prices,
financial turmoil in China and worries over credit conditions and corporate earnings
prompted fears that the U.S. economy may be heading for recession. This has put
additional downward pressure on equity markets and other risk assets.
Top Themes as a New Year Begins
1. The odds of a recession are lower than what equity markets are forecasting.
Following what proved to be a mediocre period for equities last year, the drastic decline
has some believing the U.S. is on the cusp of a recession. It looks as if stocks are pricing
in a 50% chance of a recession; when looking at underlying trends in the economy, the
odds may actually be closer to 25%, in line with the typical recession risk usually
witnessed during any period in an economic cycle.
2. Corporate earnings remain under pressure. Fourth quarter results are expected to
show a 6% decline, which would result in profits contracting for three consecutive
quarters for the first time since 2009. Analysts are also forecasting a modest decline for
the first quarter.
3. Falling oil prices should help the U.S. economy but could cause some short-term
pain. Lower energy costs are long-term positives for consumers and businesses and
should be a positive for trade. In the near-term, however, the sharp collapse is causing
credit issues, hurting earnings and sparking deflationary fears.

Fundamentals Are Stronger than What Markets Reflect

The sharp market downturn appears to have turned what has long been concern over
weak economic growth into more dire forecasts of an end to the bull market and the
onset of a recession. Investor sentiment has imploded in the face of worries over the
fragility of the economy, a slowdown in U.S. and Chinese manufacturing, confusing
signals from Chinese policymakers and another collapse in oil prices.
Importantly, however, the negative turn in sentiment is not due to a significant
fundamental shift in economic data or a policy mistake. Most fundamental conditions
remain steady. The U.S. economy is growing slowly and wages are accelerating while
broader inflation remains contained and an average of 200,000 new jobs are being
created on a monthly basis. Federal Reserve policy is still easy and the European Central
Bank, Bank of Japan and Peoples Bank of China are all in easing cycles. Outside of the
equity downturn, other financial assets are not showing severe dislocations. Non-energy
fixed income credit sectors are relatively stable, and government bond yields have not
dropped by as much as would be expected if the economy were severely worsening.
The main fundamental changes are the economic downturn in China, the drop in the
value of the yuan and the corresponding free fall in oil. Falling oil prices by themselves,
however, do not indicate an imminent recession. Rather, they reflect excessive supplies
of oil around the world. Nor is China headed for a hard landing. Growth there is
slowing but remains positive.
The challenge for investors in this environment is to decide whether to turn defensive
on a short-term basis to guard against further downturns, or remain patient on the
expectations that panic conditions will ease once investors realize a recession is not in
the cards. The latter strategy appears to be more prudent. In many ways, the current
scenario is similar to the market turmoil in 2010 through 2012 when periodic crises
resulted in a series of sharp sell-offs and subsequent rallies in risk assets.
So what will it take for markets to break out of the current downdraft? For one, firmer
economic data from China and evidence that policymakers can manage the countrys
financial conditions will be helpful. Additionally, signs that both U.S. and Chinese
manufacturing levels are recovering will help stabilize the markets. Finally, stabilizing oil
prices would go a long way toward improving investor sentiment and settling market
volatility.
Finally, the speed of the market decline has been incredible, by any historical standard
it feels like a whoosh straight down. But as disorienting as this all feels, the truth is that
double-digit declines from prior market highs are not an anomaly they are the norm,
statistically speaking. In fact, this happens during 2 out of every 3 years. The markets
ultimately recover and go on to new highs, and declines can and do occur even when
the economy is growing, such as in 1998 in the midst of the technology and productivity
boom, and in 2010, 2011 and 2014 in the midst of the current recovery cycle.
It will no doubt take some time for improvements to occur, but economic fundamentals
are more solid than equity prices reflect. As such, investors should stay with a
moderately pro-growth investment stance and equities may present favorable long
term opportunities at current price levels.

Amin Khakiani
January 21, 2016