2015 Wrap-up and Outlook for 2016
Posted by Team HFM on January 06, 2016
On the opening day of 2016 the S&P 500 index had an inauspicious start, falling 1.5%, which erased the 1.4% gain for all of 2015 – not exactly what we were hoping for. Yet for all of the focus placed on the first day of the year, we don’t believe it is indicative for the year as a whole, despite the laundry list of reasons that suggest it could continue downward.
The first quarter could be a volatile time for securities. GDP predictions for the 4th quarter 2015 are trending lower, in the 1% range. The past two winters seem to have impacted 1st quarter GDP with growth about flat for those quarters. While the full year growth in GDP may turn out to be in the 2 to 2.5% range as it has been the past few years, the first quarter of the year is not likely to provide optimism for above-trend growth.
2015 saw earnings for the S&P 500 companies fall as lower commodity prices (particularly oil) eviscerated the earnings of energy and materials companies. At the same time, the spending increase by consumers who benefited from lower oil prices failed to materialize. The sharp rise in the dollar hurt corporate earnings, as many S&P 500 companies rely heavily on exports. Consequently in 2016 a mere stabilization of oil prices and the dollar and some additional spending by consumers could reverse the fall in corporate earnings and provide a positive environment for improvement in stock prices. With the valuation of stocks now just under historical averages, conditions are ripe for a positive year.
The bond market seemed to anticipate that the Federal Reserve would begin to raise interest rates at each of their meetings during 2015. This anticipation, followed by the let-downs of Fed inaction, provided for a jerky sideways movement in rates for most of the year. In December, at their final meeting, the Federal Reserve finally did increase rates one quarter of one percent. Spent of its anticipatory emotion, the market yawned at the event and little else changed. Fed members are forecasting four rate increases during 2016, while market participants via the futures market seem to think only a couple of rate increases will occur. For 2016 we anticipate that the Federal Reserve will continue to raise rates at a very slow pace, possibly a quarter of a percent at every other meeting. Compared to prior cycles, that would be a snail’s pace. It is important to note that the rates the Federal Reserve is changing are overnight lending rates. Longer term rates that affect most bond portfolios are more likely to move based on changes in economic growth and inflation. Since both of those measures remain quite subdued, we feel that we are unlikely to see a significant rise in mid to long-term bond yields. Thus bond returns will likely remain low as yields are low and capital gains are unlikely.
That said, markets often over-react. We would not be surprised to see a fairly short lived spike in rates. Given the lack of real strength in the economy we would not anticipate that rates could stay higher. If we do get a spike, we would look at it as an opportunity to lock in higher bond rates.
Several of the peripheral asset classes (satellite bonds and alternatives) which HFM uses in many portfolios had poor performance in 2015. Each had their own circumstances, yet we remain confident that these asset classes will add significant value to portfolios over a market cycle, both in return and diversification.
As always, there could be a so-called “black swan” event lurking in the wings of the stage, threatening to make an appearance. While the list of catalysts that could draw out a black swan is long, it appears to be dominated by:
- The Middle East: With the withdrawal of U.S. leadership in the region, shifting alliances, brinksmanship and terrorist armies threaten broader regional conflict and a return to higher oil prices.
- China: As that economy shifts its emphasis from manufacturing and growth of infrastructure to consumerism, economic growth has slowed and commodity prices have plunged. Avoiding a major recession in China is key to world economic growth. Recession there is unlikely, but not out of the question.
- Presidential Election: Over the last several election cycles negative advertising seems to have increased and had a dampening effect on market optimism. That, together with uncertainty, which the markets abhor, could moderate returns which are already expected to be mediocre.
- Terrorism: As awful as the terrorist attacks subsequent to 9/11 have been, they have not been of a sufficient scale to have more than a short-term effect on the markets. Some analysis indicates that ISIS is intent on increasing terrorism to draw the West into a war. Let us all pray that they are unsuccessful.
There was a study a few years ago in which people in the waning years of their lives were asked what they regretted the most. Surprisingly, topping the list was that they had worried too much during the course of their lifetimes. We don’t know for sure, but we assume that those respondents weren’t suggesting that we all live a life of naive optimism. We think the message was that too much time and energy was spent on worrying about things they couldn’t control, rather than the pursuit of activities that would have promoted a sense of perspective and well-being.
We look forward to doing what we can to help while you focus on those things that are going to promote a happy and healthy 2016 for you.