2015 in Review
Happy New Year! As we turn the page from 2015 to 2016 we want to take some time to examine what happened in the financial markets in 2015 and what we see on the horizon for 2016.
The year 2015 was marked by a fair bit of market volatility. In fact, if you looked at the value of the S&P 500 index in a vacuum on January 1, 2015, promptly fell asleep, and then woke up on December 31, 2015, you’d think that very little happened during the year. As most investors know, however, the market experienced significant fluctuations up and down during the year, particularly during the second half of the year.
During 2015, generally only the very largest of large-cap U.S. equities saw positive returns. In fact, although the S&P 500 only declined -0.7% on a composite basis for the year, that number is somewhat misleading. The top 50 stocks in the S&P 500 index were up an average of 1.52% for the year while the bottom 50 stocks in the index were down an average of -11.87% on the year. A further look “under the hood” shows that growth stocks generally outperformed value stocks within the index. The 200 stocks within the index with the highest Price/Earnings ratio (P/E) were on average flat or up slightly for the year while the 200 stocks within the index with the lowest P/E ratio were down an average of greater than -5%. Additionally, stocks that paid higher dividends generally underperformed stocks that paid little or no dividends. Mid cap stocks, small cap stocks, international stocks, commodities, and high yield bonds also experienced moderate to significant price declines in 2015. Falling oil prices, extended uncertainty until the late fall over the Federal Reserve’s interest rate tightening posture, earnings estimates that failed to meet expectations in the latter half of the year, and a strengthening dollar against various international currencies all served as headwinds against market performance.
Looking ahead to 2016, due to weaker than expected earnings estimates, valuations of U.S. large-cap equities are currently a bit pricey on a historic basis. However, such valuations are not necessarily indicative of a looming market pull back. Economic data has generally been a stronger indicator of market performance and while the economy continues to grow at a slow pace, the data is somewhat mixed. In early December, disappointing manufacturing reports came in weaker than expected and housing sales and starts have slowed. However, the rest of the economy appears to be fairly healthy. The service sector, auto sales, and employment data have been strong and a consensus of economist estimates targets U.S. GDP growth of 2.5% for 2016. Moreover, with the plunge in oil prices, inflation remains very low.
Looking overseas, the strengthening dollar over the past couple of years has been a significant drag on international equity returns. Moreover, while the U.S. Federal Reserve is in a tightening mode, much of the rest of the world, specifically Europe and China, are easing. Therefore, the trend of a strengthening dollar against many of the world’s overseas currencies appears poised to continue in 2016. Having said that, while we do believe that near term continued volatility in the international equity asset classes are very possible, we believe that many of the international equity markets appear to be in “oversold” territory, presenting significant opportunity for solid returns over the next few years.
As we write this, the U.S. equity markets closed down about 1.5% for the first trading day of 2016. This has only happened 14 times in the history of the S&P 500 prior to today. However, 80% of those times, the rest of January has produced a positive return, with median gains of 5%.
With all of this market and economic commentary in mind, it’s easy to lose sight of the fact that these are all short-term data points. A Bloomberg survey of 14 “market strategists” from various large financial institutions (such as Goldman Sachs, Deutsche Bank, Morgan Stanley, and UBS) provided their prognostications as to what the S&P 500 index would return investors in 2016. The estimates were all over the map, as it were, ranging from a low of 1.45% to a high of 13.53%, with an average among the 14 estimates of 7.06%. While such prognostications may be fun to consider, we find that in practice, they are utterly meaningless and often wrong.
The various national and local media outlets have a tendency to sensationalize short-term market data in an effort to stoke strong emotion and drive ratings. Further, they routinely stoke the myth that there are market “experts” that can predict market activity and time it effectively. However, the data overwhelmingly shows that nobody can time the markets effectively. That’s why it’s important to maintain a long-term perspective when it comes to investing. As you’ve heard us say many times over the years, proper asset allocation within an investor’s risk tolerance is the single biggest driver of portfolio returns. As the attached chart clearly shows, determining which asset classes will outperform and which asset classes will underperform on an annual basis is nearly impossible to predict. It is far more important for investors to be as diversified as possible, with appropriate levels of exposure to each asset class.