Why 2015 is still relevant in 2016

Why 2015 is still relevant in 2016

During our annual account reviews at The Legacy Foundation, we review and discuss key events that shaped the investment environment in the previous year and how these events factored into our decisions regarding portfolio allocations.

While no financial adviser has a crystal ball, we do use macro research and technical analysis in our investment process to provide insight as to the most appropriate investments to populate our clients’ accounts.

With the start of 2016, the S&P 500 Index declined -6% during the first week of trading and by the second week was down -10%, marking the worst start to a new year in stock market history. We called for a correction in May 2015 which came to fruition in August.  Although the market did recover, unfortunately upward momentum lacked staying power as China and other external factors contributed greatly in driving stocks lower this year.

While we have taken defensive measures in client portfolios, we wanted to reiterate that we remain thoughtful about maintaining the allocations that are paired with our clients’ risk profile.  We never want to attempt to outright time the market, which is too often a fool’s game and could result in our missing out on the next meaningful rally.

What follows are five key events of 2015 that we believe impacted portfolio performance last year and continue to have significant influence on returns in early 2016.

China

China’s economy began slowing in 2014 and continued to do so at a faster rate in 2015. China has the second largest economy in the world and its slowdown in growth is certainly affecting the economies of other countries. For several years now, China has been transitioning from a manufacturing and export-driven economy to one more like the U.S., a consumer-led economy. Also, China’s lack of transparency is not helping matters. Many already doubt that the economy’s 7% annualized growth rate is an accurate number, and the Chinese stock market remains very volatile as investors don’t know what to believe.[1] Note in the chart below that the Shanghai Stock Exchange Composite shot up near 60% in the first half of last year only to see all the gains disappear in the summer. This composite is down approximately -19% in 2016, serving to further increase volatility in global stock markets.

china

Interest Rates

Last December the Fed raised interest rates, but by just 0.25%. Interest rates still remain at historically low levels. In 2008, the yield on the 10-year Treasury bond was about 4% -- today it’s below 2%. The chart below shows that this yield has been much higher in the past, well above 4%. During the last several years, retirees and those depending on interest for income have had to invest in equities to earn a higher yield through dividends. But this quest for higher yield has involved many investors taking on more risk than is appropriate for their age and circumstances. Considering this extended period of low interest rates, retirees have been forced to recalibrate their income expectations and adjust their spending habits accordingly. Interest rates are expected to rise in the future, but it could take time to return to “normal” levels.

interest rate

Quantitative Easing (“QE”)

QE is when the Fed buys back government securities to drive down interest rates and expand the money supply in an effort to stimulate the economy. As shown in the chart below, the Fed conducted four programs of QE from the end of 2008 through 2014, with 2015 being the first QE-free calendar year since 2008. As already discussed, QE definitely worked with respect to lowering interest rates. However, it remains to be seen if the economy can prosper and thrive on its own without the aid of QE.

QE

Oil

After getting above $100 in 2014, the price of crude oil declined -31% last year and another -25% by mid-February of this year. However, crude oil has staged an impressive rally of late, surging almost 14% in March alone. With its current price getting above $40, oil has a long way to go to get back to previous high levels, but this +50% move from its low of $28 could indicate the downtrend has been broken. Reasons for crude oil’s rally include rumors of the Saudis possibly agreeing to cut production coupled with a weakening US dollar. As shown in the chart, crude oil and the US dollar tend to move inversely.

crude oil us dollar

Our near-term outlook on equities continues to be cautious. The defensive changes we implemented in late January and early February were event-driven and remain in place. At that time we established positions in a consumer staples sector ETF, a gold bullion ETF and a long-term Treasury ETF. The consumer staples ETF holds stocks of companies that offer products that consumers tend to always purchase, regardless of economic conditions. Examples of such companies include Procter & Gamble, Coca-Cola, Philip Morris, Kroger and Clorox. Consumer staple stocks historically outperform when the stock market is weak. Gold and long-term Treasuries also tend to do well during volatile periods for the stock market since investors view these investments as safe havens.

We continue to be underweight non-U.S. stocks, although our thinking could change on this stance if the US dollar continues to weaken and commodities continue to rise. Growth stocks remain favored over value stocks, but the growth fund in client portfolios has so far experienced a very difficult 2016. The Prudential Jennison Growth Fund has an excellent 15+ year track record of outperformance, and yet this year only three of its top-20 holdings have managed to beat the S&P 500. The start of 2016 has been rough for several very good growth funds, yet we believe long-term results should guide our decisions and not less than three months of performance.

It’s important to keep in mind that although the daily news may appear to be overly dour and depressing, all is not bad. Unemployment is at a multi-year low of 4.9%, wage growth has been trending up for nearly two years, there continues to be few, if any, signs of a recession in the U.S., the world remains relatively at peace with no major wars or skirmishes unfolding – just to cite a few upbeat items. Maintaining an objective outlook is what we strive for every day, not allowing subjective emotions or personal opinions to interfere with seeing things as they truly are.

[1] http://www.wsj.com/articles/china-economic-growth-falls-below-7-for-first-time-since-2009-1445221368​

Source for all charts and return data: Stockcharts.com

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