The NCAA Men’s College Basketball Final Four is set. North Carolina, Oklahoma, Syracuse, and Villanova are headed to Houston, TX to determine this year’s hoops national champion. In that spirit, we share our own Final Four for the stock market this year: China, earnings, the Federal Reserve (Fed), and oil. Stock market investors may not storm the court at the end of this year, but we do continue to expect mid-single-digit total returns for the S&P 500 in 2016[2] based on our assessment of our “Final Four.”

Semifinalist #1: China

China remains a primary source of concern for markets. Economic growth there has slowed considerably in recent years, from double-digits to a potential sub-6% pace currently, and some fear a “hard landing” and potential growth in the low single-digits. A series of missteps during the summer and fall of 2015 with its currency and equity markets led to a loss of confidence in Chinese policymakers. Markets remain concerned about a potential sharp devaluation of the Chinese yuan that could lead to an Asian currency war, similar to what occurred in the late 1990s. Capital outflows from the country have been significant in recent months, with pending Fed rate hikes adding to the challenge. A lot of work remains to clean up the bad loans in China’s banking system, and property prices remain bubbly in many regions.

More recently, however, Chinese authorities have sounded more rational and appear to be in control. Government officials have sent markets soothing signals that they won’t abruptly devalue the currency and will do whatever it takes to hit China’s (lowered) economic growth target. The Fed has dialed back its projected pace of rate hikes in 2016 (more on that below), which, along with gains over the past several weeks in global equities and commodities, has taken some pressure off Chinese capital markets.

So for now, the market seems to be satisfied that Chinese authorities are saying (and doing) the right things. But for U.S. stocks to make another move higher, markets may need to gain more comfort with China’s growth outlook and confidence in the yuan.

Semifinalist #2: Earnings

This entrant into our tournament could just as easily have been the U.S. economy. Although the two are closely connected, earnings, not economies, drive stock prices. Not only do companies face a challenging global economic environment, but a strong U.S. dollar and the energy sector downturn continue to weigh on profits. Depending on the source of profit calculations, the current quarter (first quarter of 2016) will mark the fourth or fifth consecutive quarter of flat or falling earnings. Expectations for a return of earnings growth have been pushed into the second half of the year and may not reach the long-term average (approximately 7%) until 2017.

Developments in recent weeks have provided some encouraging signs. Oil has rebounded sharply, gaining roughly 50% since the February 2016 lows, and energy sector estimates may now be at least close to what the industry could achieve. The U.S. dollar has pulled back about 4% from its December 2015 peak, and is up only 2% quarter to date versus the first quarter 2015 average, after rising as much as 15 – 20% year over year throughout 2015. During fourth quarter 2015 earnings conference calls in January and February 2016, there was hardly any talk of recession (see our Weekly Market Commentary, “Corporate Beige Book”). And corporate profit margins for the S&P 500 have remained resilient outside of the energy sector, despite the emergence of some labor cost pressures.

Bottom line, we expect earnings growth may accelerate late this year and be a key driver of potential additional, albeit modest, stock market gains in 2016. We believe mid-single-digit S&P 500 earnings growth during the second half of 2016 is achievable based on continued 2 – 3% U.S. gross domestic product (GDP) growth,[3] resilient profit margins, and stability in energy and currency markets.

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