2015 Q4 Market Update

State of the Markets

Welcome to 2016. Out with the old and in with the new.

Equity markets started off the final quarter of 2015 with a strong recovery from September’s correction, but then drifted mostly sideways and lower through the final months of 2015. This resulted in a relatively strong fourth quarter but a lackluster year for stock markets around the world. As has been the case in the recent past, the U.S. equity market performed better than international markets, which performed better than emerging market equities. The U.S. bond market delivered a small but positive return in the wake of the long awaited 0.25% rise in short-term interest rates initiated by the Federal Reserve in December.

The total returns for major asset classes are below.

2015.21.31 4Q

Last year’s returns are already somewhat overshadowed by the first week of January, which saw equity markets once again retreat on worries that China’s slowing economy and devalued currency will impact the rest of the world. As I write this letter (6 trading days into the 2016), global equity markets are down approximately 6%.

You may hear (supposed) experts proclaim that January sets the tone for the year and these results all but guarantee a bad outcome for 2016. As is usually the case, it is easier to pontificate than to check the facts.

2016.01.13 January versus Full Year

As the chart above illustrates, in the 36 years from 1980 and 2015, the S&P 500 suffered a negative January on 14 occasions. Of those 14 instances, about 60% resulted in a positive return for the year, so as uncomfortable as this last week has been, it does not predetermine the outcome for the year.

2015 - Year in Review

While there were no huge bumps in the road during 2015, it felt like there was not much in the way of good news either. The fact that investment returns were slightly negative did not help. We took all the risk but got none of the reward.

Overall the year reminds us of a classic children’s book called “Alexander and the Terrible, Horrible, No Good, Very Bad Day” in which Alexander, a boy in grade school, sufferers through one small mishap after another until they add up to….well, the title of the book. So, what were the small mishaps encountered last year? There were a number of them:

  • Significant declines in oil and gas prices caused a ruckus in the energy sector
  • Continued strength in the U.S. dollar negatively impacted exports and corporate earnings throughout the year, resulting in a year over year decline in U.S. corporate earnings
  • China’s economic growth slowed to the 6% range
  • The Federal Reserve’s arduous path to normalizing interest rates - choosing not to raise rates in September after signaling the opposite, then increasing rates by 0.25% in December
  • Continued conflict in the Middle East and the ongoing refugee crisis

    This is by no means a complete list of 2015’s ordeals, but there is no single issue that would or could tip the U.S. economy into a recession or justify a bear market in stocks. In fact, nothing on this list is anywhere near the severity of what we faced in 2007/08 (collapsing home prices, mortgage defaults, bank insolvency, etc.) and several could even be interpreted as being good for the economy in the long run.

This is by no means a complete list of 2015’s ordeals, but there is no single issue that would or could tip the U.S. economy into a recession or justify a bear market in stocks. In fact, nothing on this list is anywhere near the severity of what we faced in 2007/08 (collapsing home prices, mortgage defaults, bank insolvency, etc.) and several could even be interpreted as being good for the economy in the long run.

That said, we saw quite a bit of volatility throughout the year and a typical balanced portfolio likey wound up slightly below where it started, which is never an enjoyable scenario. However, I would much rather slog through a stagnant year then suffer through a significant correction. Hopefully, this “pause” will allow fundamentals to catch up to prices and set the stage for more growth in the future.

Oil – How Low Can it Go

The price of crude oil has fallen from over $100 to about $30 per barrel over the last 18 months. This low price of oil, while good for consumers, seems to be of significant concern for both the economy and the stock market for several reasons:

  • Demand for oil and gas is seen as a leading economic indicator and thus a decline in price is seen as potential evidence of a slowing economy
  • Low oil prices have resulted in a significant decline in earnings for oil producers which has had a negative impact on corporate earnings overall
  • Low oil prices has made production unprofitable in some areas of the country which has resulted in shuttered wells and laid off workers
  • Low oil prices has adversely affected countries whose economies are highly dependent on oil and gas production

All of the above is true. However, just as trees don’t grow to the sky, oil prices will not fall to zero. Ultimately, the price of oil is driven by four things – supply, demand, inventory, and value of the U.S. dollar. Changes at the margin of all four have recently worked in favor of lower prices, but as production is cut, demand increases, and inventories are depleted, the opposite should be true in the not too distant future (see the chart below). As the saying goes “there is no cure for high prices like high prices” and the opposite will be true as well.

2016.01.13 January versus Full Year

Conclusion

2015 was a lackluster year and 2016 is (so far) off to a shaky start. Times like these can wear on the patience of long-term investors, but we are hopeful that we will see a return to the trends of modest economic growth, improved corporate earnings, and low inflation – an environment that should be conducive to positive investment returns going forward.

 

Posted by Jay Healy at 11:54 AM
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