2015 Market Review & 2016 Outlook
January 4, 2016
2015 proved to be a very challenging year in the market. The S&P 500 dropped 0.7% in 2015. This broke some major historic trends:
- This was the first time that a year ending in “5” declined since 1885 (this is not a typo).
- It is also only the second time since 1939 that the S&P 500 experienced a loss during a pre-election year. Pre-election years, the third year of a president’s four year term, have historically been the strongest of the four years as the reigning administration historically has tried to stimulate the economy ahead of an election.
- None of the 12 asset classes that we track (which includes: gold, commodities, the U.S. Dollar, domestic stocks,international stocks, emerging markets, and bonds) posted double digit gains last year. This has only happened once (in 2001) in the last 28 years.
- None of the nine Russell style boxes (i.e., mid-cap growth, small-cap value, etc.) topped 10% last year. This has happened six times in the past 30 years. All but one of these years (1994) was during a bear market.
- None of the 10 S&P 500 sectors grew by double digits. Again the previous six times this has happened, the S&P 500 was in a bear market.
- None of the seven international regions rose more than 10% for the first time in four years.
- Volatility spiked to its highest level since the Great Recession and we experienced our first 10%+ intra year decline since 2011.
As I always state, I find any attempt at predicting market movements to be a futile exercise of ego. Bold predictions are typically made by those trying to make a name for themselves. As I repeatedly say, no one has tomorrow’s newspaper and while I do have a crystal ball here at the office (I really do) it has never provided any guidance. If you keep repeating your predictions you will eventually be correct just like a broken clock is correct twice a day. So rather than trying to predict tomorrow, let’s discuss what looks good and what keeps me up at night about our current market environment.
What I Like About Our Current Markets
The Strength of the US Economy
There have been many critics of the sluggish recovery that the United States economy went through after the Great Recession. Say what you will, our economy continues to chug along with moderate growth and no signs of inflation of any kind. Please remember that slow and steady wins the race. Our economic growth is solid.
The S&P 500 is Properly Valued
The S&P 500 looks a bit rich if you look at its P/E ratio over the past 90 years. I have a difficult time comparing how companies operated in the 1920s and 1930s compared to today. If you look at the valuations over the past 25 years the S&P 500 is properly valued.
U.S. Companies are Healthy
The companies that make up the S&P 500 are very healthy. Corporate cash as a percentage of current assets is almost at all-time highs. Companies are rewarding their shareholders by paying record dividends and buying back their shares (an indication that they don’t see any better investment opportunity) at near all-time highs. Corporate profit margins are off their highs from a few months ago but are still at very high historical levels.
Our Deficit Remains in Check
Everything is relative. A $461 billion dollar deficit sounds incredibly high. Any deficit, as far as I am concerned, is a bad figure. Given that we have had only one surplus in the past 45 years, controlling our deficit is critical to our economic future.Understanding what $461 billion means is also critical. We look at our deficit as a percentage of GDP. We are currently a 2.6% deficit to GDP which is lower than our deficit during all of Reagan’s terms as president and lower than most of the time both George H.W. Bush and George W. Bush were in office.
What Keeps Me Up At Night
The US Dollar
A strong dollar was one of my biggest concerns last year as I wrote this exact piece. The dollar, as mentioned before, was up 9.37% last year. It was the strongest performing asset class in 2015. As I write this, the euro to dollar exchange rate is 1.083,as seen below. If the Fed continues to raise rates (as they have indicated) and the European Central Bank continues its quantitative easing (as is expected) the dollar could be at a 1 to 1 ratio by the end of the year.
Rising Fed Fund Rates
They finally did it. The FOMC raised rates for the first time in almost a decade, ending almost seven years of a zero interest rate policy (ZIRP). We all knew that the Fed would have to raise rates eventually. Their timing is what I’m most concerned about. As we’ve discussed, much of the world is trying to stimulate their economies by performing quantitative easing, something we were doing just a few years ago. Raising the fed funds rates as everyone else is diluting their currency will make the dollar strengthen even faster (not a great thing, as discussed above).
So why is the Fed raising rates? Typically the Fed raises rates to slow the U.S. economy and curb inflation. That’s not the case right now. We are in uncharted waters. The Fed is raising rates to reset one of the levers they have to stimulate the economy if we were to see a future slowdown. They feel that the economy is strong enough for them to raise rates without impacting current growth. I’m concerned that they may be right, at the wrong time.
Slowing World Economy
Purchasing Manager Index (PMI) is often a very good indicator of economic stability. A PMI reading above 50 indicates that manufacturing is expanding. Anything below 50 means manufacturing is contracting. The JP Morgan PMI finished the year at 50.9, down 0.2 points from the prior month. The global economy’s recovery from the 2012 recession (the U.S. didn’t participate in this recession) remains on track.
Most developed nations continue to show economic resilience. All of the BRIC economies contracted in the past few months. Further deterioration in the global economy would warrant Polaris Greystone to get defensive with our portfolios.
As I write my annual reviews I go back and review what I wrote the year before. I can proudly say that we got it mostly right. Two of my biggest fears from last year were that the dollar would continue to strengthen and that oil would continue to drop in price. Both happened. My last fear was that we would end our seven year winning streak, which also happened.
As we begin 2016 fears of China brew. Saudi Arabia and Iran are at odds with each other. These will most likely be short-lived news bites. Every year there are always some possible headwinds that could impact the markets. Just like every year there is also opportunity. This is why we tactically manage money to play “defense” when risk rises in the markets and over allocate to equities when risk subsides. It is why we change the weighting of our equity positions in an attempt to add value by overweighting sectors, asset classes, or international regions, depending on the Polaris Greystone strategy in which you are investing. We are not afraid to aggressively play defense or eliminate investment in segments of the market where we see significant weakness. It is our ongoing duty to balance the true risk in the market with opportunity cost, something we pride ourselves on doing so well.
We welcome you to review your portfolio with your Wealth Advisor to ensure that you are in the most appropriate strategy to help you accomplish your long-term goals.
As always, I welcome your comments and questions.
Jeffrey J. Powell
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