OREANDA-NEWS. March 23, 2016. After the winter of our discontent, the arrival of spring ushers in a new start for stocks. The fifth straight week of higher prices has pushed the S&P 500 all the way back to even for the year thus far, after having fallen as low as -10.5 percent by February 11, when the price of oil bottomed.  The market leadership in the rebound has been concentrated among the most economically sensitive parts of the market, mostly the same sectors that led the way lower.

The weakness that began the year was led by financial stocks, followed by consumer discretionary, healthcare, and materials. Energy stocks were decidedly weak as well but were no worse than market performers through the February trough. The rebound, however, has been led by the energy sector, followed by materials, financials, industrials and consumer discretionary. Healthcare has been a noticeable laggard.

This round trip seems to suggest that the two biggest initial concerns among investors, slowing economic growth and tightening monetary policy in the U.S., have receded as a headwind for stocks. Indeed, the economic data in the U.S. has firmed somewhat and the stance of central banks globally, including the Federal Reserve, has taken a decidedly more dovish turn.

The Domestic Economy Appears Strong

It was just back in December that the Fed raised the overnight rate for the first time since 2006 and indicated at the same time that it expected to raise rates in quarter point increments four more times in 2016. However, at its meeting last week, the Fed backed off from that estimate, indicating that it now anticipates just two additional rate hikes this year. While the Fed seemed relatively optimistic about the performance of the U.S. economy, it was clearly mindful of weakness overseas. That same concern led the European Central Bank to expand the scope of its own stimulus program one week prior. In January, the Bank of Japan announced the adoption of negative interest rates in its latest attempt to jumpstart activity.

Of course, there is no guarantee that this latest round of monetary policy activism will have its intended effect. Skeptics abound, including former Fed chairman Ben Bernanke who warned last week that monetary policy was reaching its limits. If so, that leaves two levers for a possible reacceleration of economic activity. The first is what economist John Maynard Keynes called animal spirits, or the relative disposition of individuals to act as economic agents. When individuals are optimistic, activity tends to rise. The opposite is true as well.

But in the U.S. consumer confidence has stalled, and actually drifted somewhat lower over the past twelve months. That is not to say that consumers have turned pessimistic, but rather that they remain cautious. In other words, animal spirits are relatively subdued. We see the same pattern in Europe and in Japan. The second lever is fiscal policy, including structural reform. Increased government spending, if done effectively, can lift activity. But the prospects for such are limited by the already bloated debt levels in many countries. Structural changes, including tax and labor market reforms, offer more lasting benefits. But these require political compromise, which comes slowly or not at all in the current environment of ideological polarization.

How Long can the Rebound in Equities Last?

All of which raises questions as to the sustainability of the current rebound in equity prices. Factset now estimates first quarter earnings will decline by 8.4 percent, compared to a forecast of 0.3 percent growth at the beginning of the year. The full year forecast now anticipates earnings growth of 2.5 percent, down from 6.8 percent. But that forecast implies an eventual resumption of earnings growth in the second half, after declines to begin the year.

Relative stability in oil prices and commodities more generally will have a lot to say about that, as will the relative strength of the dollar. Recent weakness in the latter and strength in the former following the recent round of central bank activity have contributed to the better tone in stocks. If stocks are to hold their gains, and possibly add to them, some firmness in the economic data and a gentle rise in animal spirits would be a welcome development.

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The S&P 500 is an index containing the stocks of 500 large-cap corporations, most of which are American. The index is the most notable of the many indices owned and maintained by Standard & Poor's, a division of McGraw-Hill.
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