New Year’s Hangover

PaulNolte-2Good riddance to 2015. The stock market spent the year treading water, finishing slightly higher (with dividends) and ahead of all the other asset classes. In a year that saw China devalue their currency, a near Greek collapse, terrorism in France and the first interest rate hike in nearly a decade, the fact that the markets did not fall apart is a testament to investor’s fortitude. If you are looking at the glass as half empty, the investors flocked to the SP500 fearing most other investments. The dollar was stronger on the year which hurt returns from international investing, Commodity prices fell hard for the second straight year and higher interest rates typically don’t bode well for bonds. The largest US stocks became the comforting blanket as buying in Amazon, Netflix, Google and Facebook pushed the index higher. Of course, now that the new-year has begun, there will be more prognosticating than usual. One thing to be sure, many of them will be wrong, but it doesn’t stop the guessing. So in that spirit, we’ll do some of our own below.

Early in the year it looked as though energy and international markets were finally coming back after a lousy 2014. That lasted until May when their declines started anew. The markets in general peaked in May as well before swooning in August on the heels of the Chinese currency devaluation. Looking at the broad markets, there is plenty to worry about coming into 2016. Many more stocks declined on the year than advanced. The returns of the few largest stocks skewed the returns of the markets. Without the 10 best performing stocks in the SP500, the index would be down over 4% and
more in line with other market indices. Earnings fell for the SP500, thanks in large part to energy. Expectations are for a huge rebound of 20+% in 2016. That could be a reach if economic growth (here and abroad) cannot get out of neutral. Valuations are expensive in the US, and even more so for the smaller stocks. The technical picture (net number of advancing stocks to declining) has been weak much of the year. The stock market will be hard pressed to repeat the unchanged performance of 2015. Expect still high volatility with a negative bias in 2016.

Even though the Fed increased interest rates at their last meeting, bonds gave stocks a run for their money in last year the performance race. Performing nearly opposite of stocks, bond did poorly in the first half of the year and managed gains during the second half. With the Fed set on raising rates at least four times in 2016, the base case is that bonds will perform poorly during the year. However, if commodity prices continue to fall, and stocks struggle to find their footing, bonds will be a bastion of calm in the raging markets. This was true in 2015, as the August melt-down in stocks saw investors race toward bonds. Like everyone else, we will be watching the economic data to gauge the Fed’s desire to raise rates. We are expecting a more gradual trajectory higher for rates. The economic data outside of the employment data does not warrant significantly higher rates at this time.

As mentioned above, the SP500 won the performance derby in 2015. REITs did better due to a higher dividend, but on a price only comparison, investors favored the large US stocks. Most of the blame for weak performance and earnings was centered on energy. The biggest question is whether energy prices moderate during the year and inflation pressures pick up. If it were only energy that was falling in price, we could buy that argument, but metals, grains and other commodities are also falling. While we are not calling for a recession during 2016, the landscape is hardly robust. With weakness in China, Russia and South American countries, the global growth picture remains weak as well. The popular call is for better performance from the commodity markets (after two dismal years), however we’d rather wait and see more
evidence of strength in the economy as well as energy prices before “calling” a bottom. After six years of strength in the US markets, it may be time to take a break.

The changing of the calendar does not necessary change the outlook for stocks. Many of the trends that have been in place during the latter half of 2015 are likely to stay in place during the early stages of 2016. We are increasingly cautious toward stocks and comfortable holding more bonds/cash than usual this year. Our focus within the equity markets will be on the large US stocks and REIT investments. We will hold some international, but focus on the largest and most stable companies in those markets as well.

The opinions expressed in the Investment Newsletter are those of the author and are based upon information that is believed to be accurate and reliable, but are opinions and do not constitute a guarantee of present or future financial market conditions.