Third Quarter 2016 Commentaries


There were a lot of noises of increased market turbulence, but not much actual volatility. There were a lot of speeches on raising interest rate, but no action materialized to fulfill those words. For the quarter, S&P 500 climbed 3.85% nearly all in the month of July.


Balancing Rock is one of the most visited sights in Arches National Park in Utah. It features a boulder the size of a small house sitting precariously on top of a boot like base. One can be easily fooled to think that such a structure would tumble in any minute. Yet through the sheer strength of the supporting pillar and its own mass, it has remained in such a position for hundreds of thousands of years. A walk around the base, one can’t help but hope an earthquake or a lightning strike does not occur at the very moment. Indeed, when I visited in 2014, one of the park rangers informed that a similar but much smaller formation nearby fell in the winter of 75/76.

Faced with the question of the stability of such a balance, one observes any minute changes of the pillar with great interest. Thus the annual gathering of central bankers around world in the picturesque mountain oasis of Jackson Hole, Wyoming became the obsession of the financial market for the past few months. In particular, the speech on Aug 26 by Federal Reserve Chairwoman Janet Yallen was to provide clue to the market on the direction of interest rate. In its usual fashion of opaqueness, Ms. Yallen did not commit to any firm timeline of rate hike, but stressed that the case for rate increase had strengthened due to stronger labor market and solid economic growth. In a subsequent interview, Fed vice chairman Stanley Fischer were a bit blunter and stated that Ms. Yallen’s speech was consistent with the view of raising interest rate twice before the yearend. Hawks certainly made the market jittery in late August. Fortunately, those are not the only kind of animal at the Fed. Dennis Lockhart and James Bullard, two regional Fed governors interjected that two rate hikes were not consistent with their own forecasts.

Fast forward to September 21, after two days of meeting, the Federal Reserve decided the best thing for interest rate is doing nothing at all. Even though this was quite expected after a lukewarm employment report from Bureau of Labor Statistics and lukewarm growth of factory activity and service sector from Institute of Supply Management. Market still rallied with S&P 500 climbing more than 1%.

While the easy money policy continues, we are at a critical juncture on the earnings front. As October commences, days will be shorter and temperature creeps lower. Soon there will be another earnings season. The third quarter of 2016 would most likely become the 6th consecutive quarters in a row of declining S&P 500 earnings. But the end is in sight. After declines of 6%, 6.5% and 2.8% in the past three quarters, the S&P 500 earnings are projected to decline 3.1% for Q3 of 2016. Given that companies like to guide their near term earnings below observed business trends so that they can easily deliver positive surprises for investors, actual earnings decline will likely be closer to 1%. As a result, earnings are falling, but the pace of decline is slowing. After this quarter, earnings are set to resume growth and continue into next year. So just as the Fed is withdrawing a degree of liquidity support for the market, another pillar may yet come to lift it and maintain our precarious balance.