2015 Economic / Market Recap
While the 4th Quarter (completely in October) saw a recovery from the lows of August and September, 2015 marked the first time since 2011 that the U.S. stock market finished in negative territory. When combined with the lackluster Global Market performance in 2014, the Global Stock market has effectively delivered no return over the last two years.
The Dow Jones Industrial Average lost over 2.2% in 2015. The S&P 500 did fare slightly better and only declined 0.7%. International markets turned in a far worse performance—emerging markets lost approximately 17% while the broad developed international markets (i.e., Europe and Japan) declined roughly 2% in 2015.
Fixed Income markets did provide a nice counterbalance to stock market volatility, but the broad U.S. bond market was up only 0.55%. However, high yield bonds (bonds rated below investment quality) saw their worst year since 2008 and declined 4.47%. Cash like investments (i.e., money markets, CDs, etc.) continued to provide investors with negative returns after inflation and taxes are considered.
In fact according to one study by Societe Generale, last year proved the most difficult year since 1937 to make money.
What went wrong?
First, the U.S. stock market has experienced a nice run since 2009 so perhaps it was overdue for a breather. This is normal and often a characteristic in previous bull markets.
Second, the positive expectations that many economists placed on falling oil prices haven’t materialized yet. So far, lower oil prices have been a net drag on the economy. It was believed that if the average American had more money in their pocket, they would spend more on consumer goods and services. That should happen sooner than later, but it didn’t happen in 2015.
Third, foreign problems seemed to persist in multitudes. From Greece’s bailout issues, the European Central Bank’s attempts to provide a spark to the European economy, terrorist attacks, fear of war outbreaks, to China’s slowdown, all contributed to a seemingly endless supply of issues that derailed foreign markets’ attempts to rally.
Finally, the constant speculation of Federal Reserve interest rate increases proved to be like a hangover that just wouldn’t go away. Janet Yellen and the Fed decided to raise rates in December for the first time in almost 10 years. The rate went up .25%–not a big deal, but certainly symbolic.
With all that being said, the U.S. economy continued to plod along. GDP numbers will be released in late January but should come in around 2.5% for the year. That was not enough growth to overcome the above mentioned issues, but that is not a recession either. We like to think of this economy as a plow horse economy as opposed to a race horse economy. We would like to see the horses run faster, but it’s more important that they move forward and not backward!
So, what do we expect in 2016?
1. The U.S. Economy Does Not Appear to be Trending Toward Recession.
In fact, U.S. GDP growth is expected to accelerate to 2.8% this year We think that is a credible estimate.
Also, U.S. and foreign corporate earnings estimates (with the exception of the energy sector) give us confidence that a recession is not in the mix this year. We have attached a recent piece produced by First Trust that summarizes the snapshot for estimates—the S&P500 companies are projected to grow at 8.62%. Small caps, health care, and technology stocks should do better than that. Growth rates like that do not suggest economic collapse.
Lack of recessionary pressure and positive corporate earnings make us hopeful for better conditions in the stock market to deliver better returns than we saw last year.
2. Expect Continued Heighted Market Volatility.
2015 marked the first U.S. stock market correction of more than 10% since 2011. Market corrections of 10% are actually quite normal (it never seems normal in the moment). We would not be surprised to see additional short term corrections this year—in fact, as of this writing, the U.S. market is down 5% in the first 4 days of trading for 2016!
It’s often hard to explain and understand the specific causes of a short term pullback. Over quarters and years, however, the stock market tends to respond to corporate earnings. Given our expectation of no recession this year and the positive outlook for earnings, we would tend to use pullbacks as buying opportunities. This is an easy way to “buy low”. We think to deploy cash and to reallocate assets to risk (where appropriate) during periods of volatility is a smart strategy.
The key in attaining positive returns is to remain calm during market fluctuations and not become emotional. Markets go up and markets go down. Always have, always will. However, over longer periods of time they tend to go up. Staying the course will allow investors to do the same.
3. More Federal Reserve Interest Rate Increases.
When the Federal Reserve raised interest rates at their December meeting it marked the first time since 2006 they had done so. In addition, Janet Yellen carefully laid out the Federal Reserve’s plan to increase interest rates an additional 3-4 times in 2016. Assuming that this actually occurs that would put the Federal Funds rate at around 1.5%-2.0% by the end of 2016.
In our opinion, the timing and size of interest rate increases is one of the best indicators to gauge the next recession or significant market crash. When short term interest rates become higher than long term interest rates we have what is known as an inverted yield curve (it even sounds scary). Historically, this is an indicator of a big problem. In the Summer of 2000 and in Spring of 2007, the yield curve inverted. Perhaps because the Fed made a policy mistake. The major stock market declines of 2000 to 2002 and 2008 are well known—the yield curve should have been a warning bell to those crashes.
The good news is we do not currently have an inverted yield curve! To be sure, we will be watching this closely in 2017—2018 timeframe.
4. Geopolitical Issues Are Numerous and May Get Worse Before They Get Better.
There seems to be many problems and hot spots around the World—Iran, North Korea, terrorism, and Middle Eastern hangover in general to name a few. Just turn on the nightly news and they will tell you how “bad” everything is. Most people can agree that U.S. leadership abroad has been weak. As we project our weakness, rogue nations and groups grow in strength.
5. 2016 Election Year
We have fielded a lot of questions from clients over the last six months about market performance during a Presidential Election Year. The thought process is that in 2000 and 2008 we had a Presidential change and the financial markets suffered! We would suggest that the market results of 2000 and 2008 more aligned with Federal Reserve action (see above) than a new president.
In reality, going back to 1970, we have had 11 Presidential Election years. Nine of those years have produced positive returns (81% positive). Of those 11, six have resulted in a Presidential change. Four out of those 6 years have produced positive returns (67% positive). We tend to like those odds.
As far as who receives their party nomination or wins the general election, it’s way too early to offer anything more than a guess. With that being said, we would anticipate a tight race with a handful of states (Florida, Ohio, Virginia, North Carolina, Iowa, Colorado) serving as the deciding factor.
So What Should We Do?
A couple of things make sense from our perspective.
First, we have most accounts on the lower side of their designated risk scale. That simply means that for sometime we have held lower amounts of risk assets (i.e., stocks) than normal. We feel that given the current environment that makes sense.
Second, we continue to hold a nice amount of cash and cash equivalents in accounts. This serves two purposes. One, these assets will provide ballast should markets take a tumble. Two, it provides us with fresh powder in the event that we have an opportunity to buy risk assets at more reasonable prices.
Third, we are on the lookout to purchase some individual securities or specific sectors in client accounts. This is something that we have historically not done a great deal of for numerous reasons. However, given the current landscape we think we can add value this way.
Finally, we understand that this is an old tune, but stay PATIENT! It is a boring cliché and we get that. However, trying to time the market over short periods of time rarely works with any consistency. Often, time is necessary for market conditions to play out and to translate into results. For clients that have 10+ years until retirement, you should not be overly concerned, but instead looking for value. For clients in retirement or within 5-10 years, our focus should be on controlling risk and looking for selective opportunity where we can find it.
As always, we thank you for your continued confidence and business! If we can answer any questions or provide any further clarification, please do not hesitate to contact us.
We hope that you and your family have a Wonderful and Prosperous 2016!
The Kiplinger Letter, volume 92, number 52