What is happening in the stock market?

After opening 2016 with the worst week on record, the remainder of the 1st quarter made it one of the most volatile since 2008, dominated by four large up & down moves of over 7%. When the dust settled, a late stock market bounce has, at least temporarily, pushed the major market indexes back towards breakeven. However, amidst a second consecutive quarter of slowing corporate profits, this surge in volatility is another warning sign of potential trouble ahead for the markets.

Following the Fed Funds interest rate hike in December, the Federal Reserve pulled back from its plan for additional increases, citing the weakness of the global economy as a cause for greater caution about the prospects for U.S economic growth. The Fed had originally projected a 1% increase for 2016, broken into several increments.

Where can I make money?

We anticipate that defensive equity sectors such as Utilities and Consumer Staples will continue to outperform the broader indexes as equity markets still face significant headwinds. Further, contrary to popular opinion, high quality bonds continue to be an attractive investment opportunity. While many projections have been calling for higher interest rates, which would be negative for fixed income, the 10-year Treasury yield has actually declined from since the end of 2013, from 3.04% to 1.78%. With the Fed backing off their more aggressive forecast of four rate hikes this year, we anticipate that investment grade bonds will continue to do well in 2016.

What is out investment outlook?

Even with the stock market’s recovery from a double digit decline to begin the quarter, we remain in a defensive posture. We still observe weak economic conditions highlighted by a second consecutive quarter of declining corporate earnings. In fact, consensus estimates are projecting a 7% year-over-year decline this quarter, which would be the worst drop since 2008, and a third straight quarterly decline. In addition, 1st quarter U.S. GDP grew at an anemic rate of only 0.5%, well below expectations.

While we patiently await signs of improvement that would justify a shift to a more constructive view, we observe a substantially elevated probability of further market weakness. We recommend proceeding with caution and believe this recent market rally presents a great opportunity to reduce portfolio risk. It is prudent to focus more on capital preservation, protecting principal, as well as targeting dividend and income oriented strategies that offer “defensive” characteristics and have historically performed well in similar economic environments.