On behalf of the Altium Investment Committee;
All of us at Altium Wealth Management wish you a Happy New Year and hope that you had a good Holiday season. While we are moving on to a new year, a brief review of the year just ended is a good lead-in to updating you on our investment strategy for 2016.
If you haven’t been following the markets closely for the last 12 months, you might think that 2015 was pretty dull and uneventful. The US stock market as measured by the S&P 500 index was essentially unchanged (down 0.7%) from a year ago and interest rates didn’t change much either (the yield on the US Treasury 10-year bond was 1/10 of 1% higher). The US economy recovered from a frigid Q1 and did OK, its GDP chugging along at a modest, but steady rate of 2-2 ½%; so the FED finally began to raise rates after talking about doing so forever, but the increase was a tiny ¼%. Employment in the US (measured by the growth in nonfarm payrolls) remained steady, while wages (measured by the growth in real average weekly earnings) were sluggish; so inflation, currently running between 1 ¼% and 1 ¾% depending on which index you use, has yet to meet the FED’s target of 2%.
The chart above shows the divergence between wage growth (in blue) and US employment growth (in orange)
The chart above shows a steady increase in year over year inflation growth, however, as of end of year 2015 the 1.26% year over year growth remains well below the fed’s 2% target
While the trends in US economic data were relatively steady in 2015, investors nonetheless experienced a pick-up in volatility as market prices reacted dramatically to what was going on abroad. Most of Europe and Japan did better than expected in response to a fresh dose of monetary ease, but China slowed faster than the markets had anticipated as its manufacturing sector contracted throughout the year (the Caixin Media Co.’s China manufacturing purchasing managers’ index was 48.2% in December, its 10th straight month under 50%, confirming continued contraction in the sector). As news of the slowdown in China came in, commodity prices fell hard, particularly the price of oil which was down 30% by the time the year was over. The emerging markets suffered a “double whammy” of lower commodity prices and a higher US $, which advanced in response to the FED’s anticipated tightening initiative, while the rest of the world’s central banks stuck with an easy money policy. As we waited for the FED to move, we worried (and continue to worry) about the news coming from China. The result was bigger moves in the markets than we had experienced in recent years.
The chart above demonstrates the increase in S&P500 volatility during the second half of the year when news from overseas shocked the market
The Goldman Sachs commodity index, in the chart above, illustrates the weakness in commodity prices over the last 12 months
In fact, we experienced a few truly “gut-wrenching” moves during the year as the tug of war described above (between the FED’s determination to raise interest rates as the US job market strengthened and pressure for lower rates from the rest of the world as China’s growth slowed and commodity prices sank) intensified. Certainly the re-emergence of the “Grexit” debate in Europe, the German 10-year Bund’s zero percent yield in the spring and the stock market crash in China in the summer also played a part. This summer the US stock market finally succumbed to a long overdue, by historical standards, double digit decline.
A reduction in market liquidity was also an important contributor to the big swings in bond and stock prices last year. New banking regulations had the effect of reducing the industry’s commitment to trading which in turned reduced liquidity in the markets. And the fact that the majority of the world’s central banks remained committed to monetary ease led to a certain “crowdedness” in global trading activity overall. The implication for investors is that markets now tend to overreact to small shifts in policy or information.
Given the volatility that we are experiencing early on in 2016, we are quick to re-affirm our longstanding commitment to recommending broad diversification in allocating our clients’ investment portfolios. 2015 was a year in which the benefits of a diversified portfolio were demonstrated often, most notably in the outperformance of the developed market international stocks (Europe and Japan) particularly in the first half of the year and bonds generally during the stock market correction in the US in Q3.
The chart above shows the 2015 relative performance of the major world stock market indexes
The chart above shows the total return of the SPY (S&P500) and LQD (Corporate Bond Index) from 8/17/15 to 9/30/15
Looking to the New Year, we believe that investors should be mindful that markets, particularly in the US, are highly priced compared to long run averages. At year end, stocks were selling at more than 25 times their cyclically adjusted earnings and bond yields were unusually low. As a consequence, investment returns in the short run may be lower than in the past. At the same time however, investors should remember the timeless lessons of successful long term investing – stay invested, don’t try to time the market, in addition to diversifying broadly. While a small amount of portfolio rebalancing may be called for given the out performance of European and Japanese stocks and under-performance of the emerging markets, we believe that our clients should for the most part leave their portfolios as they are, unless their risk tolerance has changed.
We want to give you a special note about bonds. We think that most investors should resist the temptation to reduce their bond holdings to avoid price declines as interest rates rise (and, when possible, we recommend individual bonds rather than bond funds). The rise in rates is likely to be less than some market pundits fear since excess capacity worldwide will probably keep inflation under control for some time to come. In addition, bondholders who reinvest their coupons and keep the average maturity of the bonds in their portfolios short (so that they can replace maturing bonds with higher yielding securities) will find that rising rates will be ultimately beneficial.
As 2016 unfolds, we’ll be watching China, oil and the FED closely and keep you posted on what we see. At present the markets seem to be pricing in a slower growth trajectory in China, some stability in the oil price and a gradual tightening path for the FED. But the risk of the markets being disappointed remains high, as does the overlay of continuing geopolitical uncertainty. For these reasons among others, the investment scene is likely to remain choppy. We think investors should be prepared to live with the prospect of pronounced market swings during the year.
Gregory Slater, CFA, CFP®
Chief Investment Officer
This newsletter contains general information that is not suitable for all investors and should not be construed as personalized investment advice. Past performance is no guarantee of future results. Investing in the stock market involves gains and losses and may not be suitable for all investors. The information contained herein is subject to change without notice and should not be considered as a solicitation to buy or sell any security. In preparing this newsletter, we have relied upon information provided by third parties. While we believe these sources to be reliable, the accuracy and completeness of the information is not guaranteed. We have provided performance results of certain indices for comparison purposes only. A description of each index is available from us upon request. The historical performance results of each index does not reflect the deduction of transaction or custodial charges or the deduction of an investment management fee, the incurrence of which would have the effect of decreasing indicated historical performance results. It should not be assumed that performance or the volatility of any securities held will correspond directly to any comparative benchmark index. Additionally, certain statements contained herein that indicate future possibilities are forward-looking statements. Due to known and unknown risks, other uncertainties and factors, actual results may vary materially than those portrayed in such forward-looking statements. As such, there is no guarantee that the views and opinions expressed herein will come to pass.
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