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Yesterday's largish market pullback has caused many to wonder whether more trouble lies ahead.
Big-picture, things still look good.
Where did yesterday’s drop come from?
A few factors are in play:
- The Greek election, and the growing probability of confrontation between Greece and the EU, is a real risk factor.
- The strong dollar is doing significant damage to the earnings of major corporations, which is another headwind—and one that blew hard yesterday.
- The drop in oil prices is also a serious detractor, and it's hitting the earnings of energy companies right now.
Couple these factors with a discouraging durable goods report, and you have a potential storm worse than the one that hit New England yesterday. In this light, the question might not be “why did the market drop?” but “why didn’t the market drop more?”
With the market currently very richly priced on forward earnings estimates, and those estimates coming down; with the impact from oil immediate and certain, and any benefits conjectural and deferred; and with the return of the Greek crisis, you could argue that the decline should have been worse.
Can we expect more market turbulence?
History has shown that market valuations tend to increase with economic growth—something we’ve seen in the past couple of years and that is likely to continue. Although earnings growth is slowing, earnings are still growing. And as the oil companies adjust to lower prices and other companies start to benefit from lower energy costs, that growth may well increase again.
I wouldn’t be surprised to see more market weakness, given the current headwinds, but many of those headwinds have the potential to turn into tailwinds in the medium to longer term. Just as we saw last year, the winter can be a difficult time for the economy and the markets, and the turbulence in Europe and the oil markets is making things even harder.
Like last year, though, the combination of continuing U.S. economic growth and troubles elsewhere means that U.S. markets and assets are a very attractive place to be. The stronger dollar only reinforces that case for international investors. Despite very possible shorter-term weakness in the markets, the fundamentals continue to suggest that the end of the world is not imminent.
