For investors, 2015 will be remembered for the return of volatility. While we experienced our first correction in over four years, those that remained intact with their investment plan were rewarded with a significant V-shaped recovery when the fourth quarter ended the year strong. This rebound from a difficult third quarter brought most indices back to flat or slightly negative for 2015.
Strength in the stock markets has been concentrated in those parts of the market defined by long-term growth themes, specifically in technology and health care. Gains in the indices have been disproportionately powered by a handful of mega-cap stocks, outlining the importance of active stock exposure management. In today’s investment environment, there will likely be a premium put on stocks of those best-positioned companies that are growing revenues and earnings. For example, the FANG (Facebook, Amazon, Netflix, Google) stocks were up over 60% on a cap-weighted basis during the year. Excluding only those four stocks from the S&P 500 would have brought overall performance for the index down to -4.8%. Again, like last year, the key to successful investing will involve agility, opportunism, more discipline than normal (as in raising and deploying cash at the appropriate times), and having concentrated positions in the right sectors.
So far in 2016, we have viewed global stock market performance to have been driven more by drama than data. Most important to note is that we do not see the US entering recession this year. This is significant because, barring recession, the markets do not produce successive down years.
In a recent memo to clients (see “What Does the Market Know”) world-class investor Howard Marks pointed out that “Fundamentals – the outlook for an economy, company, or asset – don’t change much from day to day. As a result, daily price changes are mostly about (a) changes in market psychology and thus (b) changes in who wants to own something or un-own something.” He asserts that converting short-term fluctuation into permanent loss predicated solely on fear-based emotions to be the “cardinal sin in investing.” The key is to track the data and act accordingly. As your investment advisor, this is our commitment to you. Mr. Marks also questioned the following, “Leaving aside China and the markets’ gyrations, have we really been seeing negative news on balance? Isn’t it just that people are fixating on bad news, ignoring good news, and tending to interpret things negatively?”
As discussed in a prior blog (see “BREAKING NEWS: Don’t Let Headlines Drive Investment Decisions”), it is imperative to go beyond the headlines and to separate the noise from the news. The current level of stock market investor sentiment appears relatively subdued with 36.7% of investment advisors bullish as of the end of December. This level of bearish sentiment suggests that cash on the sidelines has the potential to flow back into the stock market when sentiment changes. Our view is that short-term negative sentiment can create attractive entry points for informed, patient investors.
We expect the US economy to remain on a moderate growth track in 2016. This is supported by solid consumer spending trends, strength in the housing sector, continuing growth in business investment, strong and improving labor market, historically low inflation, investors far from euphoric, reshoring many manufacturing and service jobs back to the US, low debt-to-income ratio and high savings rates for households, well capitalized banks, and corporate cash near record levels. Consumer spending in real terms is up 3.2% on a year-over-year basis. New home sales are up 9%. Housing starts by 16%. And both auto sales and production are up 6%. The large services segment of the economy is showing sustained growth. While the Fed has indicated four rate hikes in 2016, we feel one more hike to be closer to actuality. In a global economy marked by low growth and controlled inflation, the Fed will remain cautious and take cues from the health of the markets.
We believe that 2016 will be a stock-pickers market with its fair share of volatility. The concerns of Chinese economic growth slowdown will likely cause bouts of price fluctuation, but most of this is old news being replayed (see “Chinese Stock Market Selloff: What’s New, What’s Not”). Likewise, stabilizing oil prices would go a long way toward improving investor sentiment, but earnings will ultimately drive stock performance. This is not a time for buy-and-hold passive investing. This is a time to think strategically within asset allocation, stay diversified, and be nimble with hedges at market tops.
We wish you a Happy New Year. May 2016 be your best year yet.