2015 in Review and a Look Ahead to 2016

Like Treading Water

Last year, the returns for most financial investment categories were flat to mildly negative. For a well-diversified portfolio of investments, the lack of progress for 2015 felt like treading water; basically going nowhere. I am sure most of you know how to swim and to tread water. Treading water takes a lot of energy just to keep your head above water. Plus, the longer you do it, the more energy you expend and you gradually sink a little lower in the water. Last year certainly felt that way. We started the year with plenty of little ups and downs in the markets. Then, by September, we had our first big pullback followed by a big rally in November, only to finish with a mild sell-off in December. For all the energy expended by investors and traders, the major US stock index, the S&P 500, was down 0.7% for the year on price. If you reinvested all your income from dividends, the S&P 500 was up 1.4% for the year. The broadest gauge of bond market performance, the Barclays US Aggregate Bond Index, was up 0.6%. Yes, that is “point 6,” or six tenths of one percent, assuming you reinvested all your bond income. Any balanced portfolio of stocks and bonds that withdrew even modest amounts of income in 2015 had mildly negative returns. So much energy expended for very little outcome.

The reasons attributed to this poor performance are many. The primary causes were the continued drop in oil prices (which helps us at the gas pump, but hurts earnings, employment and capital spending for 12% of our economy) and the strong dollar compared with other world currencies. Since our biggest companies sell over 40% of their goods overseas, those exports became more expensive and returned fewer profits back to the US. That made earnings weak and stock prices then generally lower. At different times in the year, the concern became large debt defaults. Early in the year it was Greece; later, it was and continues to be Puerto Rico. If the concern was default by the weak, it was also lack of growth by the strong. Concerns about the slowing growth rates of the economies of both China and the US kept market optimism low in 2015. Finally, the continual Fed watching and waiting for a rate hike that some mused would start in March and did not finally happen until December kept the markets guessing. So, there were plenty of reasons for investors to be nervous in 2015, which kept a lid on market returns most everywhere.

So what’s changed for 2016?

It is very possible that many of the things I mentioned above should stabilize if not improve in 2016. First, oil prices should find a bottom in 2016. Oil fell from a high of $120 a barrel to $35 a barrel recently; an $85 per barrel drop! It is mathematically impossible for oil to drop much further or production (supply) will cease, which is already happening in many parts of the world. Also, the benefits of cheaper energy should flow through to other areas of the economy more fully in 2016. Second, the appreciation of the dollar versus other currencies should slow and begin to reverse by midyear (per JP Morgan economist Dr. Kelly). Even if his timing is not perfect, currencies fluctuate from weak to strong and back like an old-fashioned clock pendulum. It seems improbable the US dollar will continue its trajectory in perpetuity. Third, the Fed waiting is obviously over; they have started to raise rates. If they are consistent with their stated intent (four rate increases of 25bps in 2016), there should be less drama in Fed watching this year. Finally, I think the other issues of too much debt and too little growth will be here to stay for a while. Mini economics lesson: that is what debt is, borrowing tomorrow’s growth for consumption now. When you buy a house the traditional way, you get a house now to live in, but you forgo a portion of your income every month for the next thirty years that you could spend on something else in the future. You have promised some of your future income to the bank in the form of debt. Not all debt is bad, but globally speaking, we have too much and that will keep future growth rates low in many places until some of the balances are paid down.

My experience leads me to believe that 2016 will not be another year of treading water. The optimistic forecast would be for investors to recognize that many of the headwinds the market faced in 2015 will now be stabilizing or turning into tailwinds, leading markets higher. The pessimistic forecast would be that the fatigue of treading water and continued market anxiety will lead to a sell-off in the financial markets and we will go underwater (briefly) and experience a typical cyclical correction. I can make a case for the markets going up or down (tilted towards up) but I do not see the markets treading water and remaining flat for another 12 months. Also, lest you think I have forgotten, we will have a presidential election in 2016 too! I do not think the outcome of the election will have much impact on the stock market directly. As I have stated before many times, the financial markets like certainty over uncertainty. As long as policy decisions and laws are expected and reasonable, the financial markets adapt regardless of the party in charge of the White House. However, the run up to the election with no incumbent running and many primaries and much fighting yet to come could distract investors and add to short-term volatility.

That is why we are here to keep an eye on all the known developments and to help you deal with life’s and the market’s surprises. We will continue to do so in 2016 and for as long as you maintain trust in Bill Few Associates and your financial advisor. The prescription for this year is the same as for last year: stay diversified and stay invested. Cash is still paying close to zero. Other than monthly living expenses and a healthy emergency fund, excess cash should be invested in prudent long-term investments that have the potential to outpace inflation and provide for a better standard of living for you in the future. The fundamentals stay the same: (1) minimize debt and use it wisely, (2) while working, maximize savings and (3) invest for the long term. Regardless of market performance any one year, those three habits over a lifetime will not disappoint anyone. Enjoy winter (I like the El Niño version this year).

Mike

Mike Kauffelt, CFA
Chief Investment Officer
Bill Few Associates, Inc.

Data Sources: Bloomberg, JP Morgan & The Wall Street Journal