If you were to check the financial markets right now, you’d think that nothing happened in 2015. As of this writing, the yield on the bellwether 10-year Treasury bond sits almost exactly where it started the year. The S&P 500 returned about 0% from where it was on New Year’s Eve 2014. Yet, the year provided new and significant developments–some good, some bad. More than likely the year ended better for the economy than it began, but that did not help investors.
Let’s start with one of the most significant changes, which is the tumbling price of oil. A barrel of oil cost $53.45 at the start of 2015, nearly half its 2014 high. Today oil is below $40.00. For most of the U.S. population, this means strikingly low gas prices–on average, below $2.00 a gallon, down from $2.76 a year earlier and an all-time high of $4.11 per gallon on July 17, 2008. In the 40 days before Christmas alone, drivers had about $8.22 billion more in their pockets than they did the same time last year. Unfortunately the drop in oil prices has not provided an economic boost to common folks such that they feel free to loosen the purses in their discretionary spending.
The next significant development was a gradually tightening labor market. The unemployment rate has been falling since its post-recession peak of 10% in October 2009, and it has taken its sweet time–falling to 5% in its most recent reading. But the fall from 5.7% at the start of the year to 5% now is significant, because it starts to hit the lower bound of what economists call the level of noninflationary growth. Naturally, economists don’t agree on just what that level is, although the general rule of thumb has been 5%–where we are now.
The final big development of 2015, which is the Federal Reserve raising the over-night, or “Fed Funds”, interest rate in mid-December. The Fed has a dual mandate, which is to promote economic growth and prevent excessive inflation. As the economy approaches full employment, the Fed is free to push short-term interest rates higher–if only to have some ammunition for the next recession.
By some measures the economy remains a bit weak, and there is a fear that rising interest rates are potentially a problem for the markets. So, any talk of multiple rate rises has the ability to cause another year of increased volatility, apprehension and a re-pricing of equities but I do not believe it will push us into recession.
For long-suffering fixed income investors who have earned little more than a cold smile from their money market funds and bank CDs, this is good news. All other things being equal, higher interest rates here could well mean a stronger dollar. If you’ve ever planned on visiting Europe, now’s the time to go: A strong dollar means your purchasing power increases abroad, that 5 euro latte could now cost you $5, rather than $7.
The High Yield Market has been………well………..in a word……….messy. Several High Yield funds have had to ask for special concessions from the SEC in order to halt redemptions so they can manage through the investor sentiment that “the theater is on fire, RUN”. When credit has problems, the stock market tends to have problems. It would be very hard to have a stock market advance while the high yield market was falling. The good news is that it looks like high yield has finally found a bottom.
Of recent interest, I have noted from more than one publication that insider buying seems to be ramping up. It is not often that there is an extreme divergent between what the public is doing and what insiders are doing. When insiders are buying the public is selling the insiders are the ones that are correct. It has been over three years since we have seen such a divergence between contrarians and trend-followers. Retail investor sentiment is a contrary indicator to market direction. When retail investor sentiment is high, future stock market returns tend to be low. When retail investor sentiment is low, future stock market returns tend to be high. For most of 2015 retail investor sentiment has been in the tank.
Given the uncertainty over the world economy, nothing is a given for 2016. But when we look back on 2015, the plunge in oil prices, the decrease in unemployment, and the first rise in interest rates in seven years will surely stand out as the most important developments.
So what does it mean for stocks? Some pundits are suggesting that we could see a 50-percent retracement in the Dow and S&P, which means the Dow could trade back at 9000, while the S&P would revisit 1030. Reasons for concern? Seven years of ultra-cheap money accompanied by massive stimulus programs enacted by every major global central bank as well as the delay in U.S. rate normalization by the Fed. All of these actions have allowed the bubble to grow, making the coming burst that much more powerful. Now, while I agree that that is a potential problem — I do not think the Fed will be irresponsible at all.
On the other side of the fence, we have predictions of a return to normal, which would dictate about a 7-percent return on stocks — add in dividends and we should return about 10 percent — that does seem reasonable to me, since I do believe that the global economy will improve — albeit slowly. I am not in the disaster camp at all. I don’t expect the Fed to move swiftly. Erring on the side of caution is the roadmap.
The sectors I like include financials, tech, medical devices, and to a lesser extent housing. Energy is clearly the hot button, as many consider money in energy to be dead for another year or so, but change in psychology could happen quickly — so while I think it is early, at some point I may be willing to take that bet. Some of the names have gotten absolutely slaughtered yet their businesses remain intact and, at some point, the market will recognize this and reward those investors.
On the international front, I would stay away from China — it is a developing market not a developed market and so therefore there is added unnecessary risk. Remember: You will get exposure to China via investments in global U.S. and European blue chips, so you won’t be missing the boat at all. I also think continental Europe is setting up to be a big beneficiary of the improving global outlook and would look to those same industries as potential opportunities. Additionally I like Japan to continue to change their investment culture and increase their attractiveness to global investors. Lastly, I like India simply because the large population and the British rule of law.
Remember though, projections are hard to make — especially when there is so much uncertainty at home and abroad. So, any projections that you do make need to have plenty of escape clauses that allow for dynamic investment decisions.
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