We expected 2015 to be a year of increased volatility and this has proven true. As mentioned in our August 27 Dino’s Blogpost, “normal market corrections (sell-offs of 10%) do occur on average every 12-18 months… It appears that the current sell-off was overdue and thus was more rapid and intense than many were expecting.” The third quarter of 2015 represented the worst quarter in the stock market since 2011 and twenty-eighth 10% correction since WWII. While we do not want to minimize the emotional impact of market sell-offs, we feel this was a very restorative and normal correction. The economic signs do not point toward a pending recession or 2008-style crash. Instead, we believe these events ultimately serve as opportunities to buy into great companies at discounts.
As it stands now, the market lows occurred on August 25 and the re-test held on September 28. The S&P 500 index has since rapidly rebounded in the 4th quarter with October gains of over 8% to bring us back within a few percent of all-time highs. It is important to be mindful of the trend. Great stocks get sold, and in some cases punished, not because of their lack of value, but simply because the trend line for the broader market has faltered. As we have recently seen on display, the fears of yesterday are quickly dashed by the realism (or optimism) of tomorrow, which is why it is crucial to keep your pulse on various economic signals and remain forward looking. With the bull market maturing, stock selection and sector weighting is even more important to achieve good performance results.
In regards to the Federal Reserve and their interest rate policy, we maintain that they will finally raise rates at the December meeting. Since this move has been much anticipated we would expect the markets to take it in stride. Additionally we do not believe the rate increase will be very significant, most likely a quarter point or less.
We remain constructive on the US economy and stock market due to several indicators. In terms of GDP expansion, the nation has posted solid gains over the past four years and unemployment rate declines have been consistent. In fact, job openings are currently at 15 year highs and initial unemployment claims are the lowest since November 1973. Consumers appear to be doing well in a low interest rate and low inflation environment as American consumer confidence data remains near multi-year highs. Related metrics show that housing permits, starts, and sales have been strong and auto sales are at record highs. At the corporate level, many large companies have shown tremendous skill in managing earnings to become immensely profitable and produce strong balance sheets. In fact, there has never been a time with more cash on balance sheets in corporate America.
The times of decline in the stock market this year have tended to occur concurrently with fears of earnings estimates being lowered. The silver lining is that 2016 estimates call for a rebound in earnings growth. Furthermore, the International Monetary Fund (IMF) does predict slightly higher global growth coming in the upcoming year. Coupled with many nations, including Japan, the Eurozone, and China, still easing their monetary policies to stimulate economies, we believe that stock prices will be supported and offer upside from these levels.
Throughout these times of turbulence, though, active management becomes even more valuable. Not all stocks or sectors will participate equally. As we have seen this year, profits from Healthcare, Consumer Discretionary, and Technology sectors are up double-digits, making them some of the top performers. Many other sectors show flat to negative earnings growth, with the Energy sector earnings per share down over 60% year-over-year. Identifying individual stocks and sectors with the strongest growing profits is more important than a bull vs bear market debate because fundamental details drive performance and those companies will ultimately produce higher returns in the intermediate- to long-term.
If the past year has been too volatile for you, we urge you to considering increasing your safety net by keeping more cash in Savings. While everyone’s situation is different, those nearing or in retirement could consider upwards of two to four years of expenses in cash or low risk investments. Most importantly though, avoid selling at the wrong time. Attempting to “sell all and buy in at a safer time” rarely works out because you have to time it right twice and it completely negates the point of having a long-term investment plan. Also, that “safer time” usually comes after stock prices have rebounded and appear less attractive. Know that our investment philosophy always maintains cash-on-hand for buying opportunities and minimizing volatility. Additionally, conservative option strategies provide extra protection and income along the way. The fourth quarter has historically provided the best performance, and although we see a rate hike in December, we do expect this trend to continue in 2015.