2015 Financial Market Update and Look Ahead

Transcription

1 Charles Sherry Director, Institutional Education Group Blue Ocean Global Wealth 51 Monroe St., Plaza West 06 Rockville, MD Tel: Financial Market Update and Look Ahead December 31, 2015 Auld Lang Syne and Key Themes Heading into 2016 In some respects, 2015 was a year that unfolded as expected predictability and surprises. The economy continued to plod ahead, the unemployment rate fell, and the Federal Reserve finally lifted the fed funds rate. Index Q4 Return %* 2015 YTD Return % DJIA NASDAQ Composite S&P 500 Index FTSE Developed ex North America Index 4 Bond Yields Yield* - % a/o Dec 31, 2015 Yield - % a/o Dec 31, month T- bill year Treasury year Treasury year Treasury Commodities Dec 31 Price, Quarterly Change* Year end 2014 Oil per barrel 5 $ $53.27 Gold per ounce 6 $1, $1, Sources: U.S. Treasury, MarketWatch, St. Louis Federal Reserve, CNBC *Quarterly: September 30, 2015 December 31, 2015

2 But we also witnessed the tale of two economies: service industries expanded at a modest pace, but falling exports (U.S. Census) and huge cutbacks in the energy sector took a toll on manufacturers. Meanwhile, the relative outperformance of the U.S. economy versus its global partners kept upward pressure on the dollar. On the equity front, the S&P 500 Index lost ground for the first time since 2008, and stocks experienced their first 10%+ correction in four years, as measured by the S&P 500 Index (St. Louis Federal Reserve). Problems with China s economy were primarily blamed for the August/September selloff, but market internals had already turned south, and anxieties attached to the global economy provided the perfect excuse for short- term traders to hit the sell button see Figure 1. While the general market was little changed, consumer issues, health care, and technology finished in the green (Bloomberg). Not surprisingly, commodity and oil- related shares were hit hard against the backdrop of sinking prices for all- things raw materials. Despite expectations for a hike in the fed funds rate and the follow through in December by the Fed, Treasury yields remain at historically low levels see Figure 1. Stock and Bond Performance S&P % S&P 500 Index- percent change 4.0% 2.0% 0.0% - 2.0% - 4.0% - 6.0% - 8.0% Fig. 1 Treasury Yield 10- year Treasury yield % /31/2014 3/31/2015 6/30/2015 9/30/ /31/2015 DATA SOURCE: ST. LOUIS FEDERAL RESERVE, U.S. TREASURY LAST DATE: It may have to do with expectations that inflation and growth in the U.S. will remain low. But very low government bond yields in Europe (Bloomberg) may also be playing a role, too. Today, cash can quickly move across borders, and rock bottom yields in Europe attract capital from abroad, which is seeking relatively higher returns.

3 A look ahead Peering into the future is always fraught with peril. No has a crystal ball, period. The bull market is set to enter its eighth year in March, but that doesn t necessarily mean 2016 will mark its demise. Many may site the upcoming election. Stocks typically outperform during an election year, right? Well, 50 years of data compiled by Deutsche Bank suggest an election doesn t provide any oomph to stocks. In other words much will depend on the economy and corporate profits. But issues that held sway in 2015 could continue to influence sentiment including earnings, the global economy, the dollar, and low commodity prices. 1- Earnings it s the lifeblood of stocks and the biggest driver of the medium and long- term direction of equities. Using monthly data going back to 1923 (Robert Shiller, PhD, Yale.edu), there is a 96% correlation between S&P 500 earnings and the S&P 500 Index. That s an extremely close correlation where 100% would mean the two variables move in lockstep. Thanks in large part to the steep drop in oil prices, profits at energy- related firms took a huge tumble last year (Thomson Reuters). In turn, that created a big headwinds to overall corporate profits see Figure 2. In fact, Q earnings, which were down a scant 0.8% from a year ago, would have been about seven percentage points higher if energy had been excluded, according to FactSet Research. Percent S&P 500 Earnings and Energy Earnings - % change from one- year ago Projected* earnings Fig S&P 500 Earnings - 60 Energy Sector Q1 Q2 Q3 Q Q1 Q2 Q3 Data Source: Thomson Reuters Last Date: *Projected earnings are subject to change

4 In addition, the stronger dollar has created additional headwinds for multinationals, which much translate sales abroad back into the stronger greenback. But note that analysts are expecting earnings to turn positive in Q and accelerate as the year progresses. Modest growth in profits would likely create a tailwind for stocks, but much of the pick- up is predicated on a continuation of the economic expansion, a bottom in oil prices, and greater stability in the dollar. Most analysts don t anticipate a recession in the near term, but the direction of the dollar and oil is a bit fuzzier. Still, the forecast for rising profits is cautiously encouraging. 2- Too much oil, commodities and the dollar Low commodity prices have benefitted nearly everyone outside of the energy industry. But woes in the commodity sector have hurt emerging market economies, and companies in the mining industry. Much of the drop in commodity prices can be pinned on China, which is undergoing a transformation from an economy that is reliant on its industrial sector to one that is more balanced between consumer/service needs and goods producers. Consequently, China s voracious appetite for raw materials has slowed, sending prices down to the lowest level in over a decade see Figure 3. But another factor that influences commodities is the dollar. The reason most commodities that are sold around the globe are priced in dollars, which means a rising U.S. currency puts downward pressure on prices. It s a plus for consumers but it hurts producers.

5 Commodities and the Dollar Ascending - higher commodity prices 500 Thomson Reuters/CoreCommodites CRB Index 450 Dollar Index - Major Currencies Fig. 3 Descending - stronger dollar /31/1991 7/31/1996 7/31/2001 7/31/2006 7/31/2011 Data Source: St. Louis Federal Reserve, FreeStockCharts Last date: Note: the Thomson Reuters/CoreCommodites CRB Index is a comprised of a broad basket of commodities, which cannot be invested into directly. Past performance is no guarantee of future performance. The Dollar Index Major Currencies is an index that measures the dollar s performance against the currencies of major U.S. trading partners. The Dollar Index cannot be invested into directly. Past performance is no guarantee of future performance. 115 Falling prices have pressured global sentiment, which in turn has hindered the broader stock market. For many at home, the collapse in the price of oil has been a bigger story. Like most commodities, oil is also priced in dollars. Note the decline below $100 per barrel coincides with the recent surge in the greenback see Figure 4. Oil and the Dollar $/barrel West Texas Intermediate Crude Oil Fig. 4 Dollar Index: Major Currencies /3/2001 1/3/2004 1/3/2007 1/3/2010 1/3/2013 Data Source: St. Louis Federal Reserve Last date:

6 While many of us are being treated to the lowest prices at the pump in years, weakness in energy has forced sizable layoffs among oil producers and big cutbacks in capital spending (U.S. Bureau of Labor Statistics). In addition to the strength in the dollar, I would be remiss if I didn t cite soaring production of shale oil, which has helped create a global glut of crude amid a drop in U.S. imports (U.S. Energy Information Administration). While production has started to decline in response to lower prices (U.S. EIA), output from the shale fields has proved to be far more resilient than many had expected. Looking ahead, what happens to China and the dollar will likely have an influence on the commodity sector this year. But what occurs in the U.S. oil fields will also play a role. Greater stability would lessen the uncertainty for investors. However, trends in commodities, including oil, tend to move in long- term cycles. 3- Problems have emerged in high- yield debt, commonly called junk bonds. Thanks in large part to woes in the mining and energy sectors, yields on junk bonds have risen as investors have bailed out of low- grade energy and mining debt (bond prices and yields move in opposite directions). Moreover, the riskiest bonds, or those with the lowest credit quality, have seen the largest jump in bond yields see Figure 5. In less than a year, yields with a CCC rating have more than doubled, and the difference in yield between higher quality junk debt (BB) and lower quality junk (CCC) has widened significantly. Yields on Junk Debt Percent Last Date: The BofA Merrill Lynch US Effective Yield BB and CCC or below provide the yield for bonds in those respective categories. Neither can be invested into directly. Past performance is no guarantee of future performance. Note: Standard & Poor s rates bonds from a scale of AAA (strongest credit quality) to D (lowest credit quality). Bonds rated below BBB- or not considered to be investment grade, and or typically referred to as high- yield or junk debt BofA Merrill Lynch US Effective Yield CCC or below BofA Merrill Lynch US Effective Yield BB 4 Spread between 2 CCC and BB 0 1/3/2006 1/3/2008 1/3/2010 1/3/2012 1/3/2014 Data SourceSt. Louis Federal Reserve, NBER Shaded area marks recession Fig

7 Rattle the bond market and you can rattle the stock market. Yet, measures of credit conditions used by the Federal Reserve indicate financial stresses in the economy remain muted entering the New Year (St. Louis Federal Reserve). If oil and the commodity sector begin to bottom and the economy continues to expand at a modest pace, historical analysis suggests that much of the damage in junk bonds is probably behind us. However, a lack of liquidity is the sector, the outside potential for a broader economic slowdown, and continued problems in mining and energy may generate additional uncertainty. While the jury it still out, a Federal Reserve that encouraged very low interest rates, which in turn, also encouraged a reach for yield by investors, may have created too much enthusiasm for high- yield debt over the last couple of years. At her December press conference, Fed Chief Janet Yellen sidestepped a question that aimed to pin part of the blame for high- yields selloff on Fed policy (Fed press conference transcript). Additional issues The most likely path in 2016 probably bears plenty of resemblance to 2015 a modest but less than impressive expansion that lends support corporate profits. But let me remind you that peering into the future is an educated guess at best. What happens with Europe, Greece, China, the Federal Reserve, and geopolitical instability can cause temporary shifts in sentiment. Then there are the unanticipated events that could hinder or fuel gains this year. Ultimately, the domestic economy has the biggest impact on markets. Even events tied to terrorism rarely have a long- term influence on stocks. Following the tragedy of 9-11, the S&P 500 Index fell nearly 12% in the first 5 trading days, but had completely erased losses by October 11, 2001 (St. Louis Federal Reserve). Historically, the long- term investor that adheres to a professionally crafted investment plan is more likely to achieve his/her financial objectives. If your personal situation has changed, let s talk. 1 The Dow Jones Industrials Average is an unmanaged index of 30 major companies which cannot be invested into directly. Past performance does not guarantee future results. 2 The NASDAQ Composite is an unmanaged index of companies which cannot be invested into directly. Past performance does not guarantee future results. 3 The S&P 500 Index is an unmanaged index of 500 larger companies which cannot be invested into directly. Past performance does not guarantee future results. 4 The FTSE Developed ex North America Index is an unmanaged index of large and mid- cap stocks providing coverage of developed markets, excluding the US and Canada. It cannot be invested into directly. Past performance does not guarantee future results. 5 New York Mercantile Exchange front- month contract; Prices can and do vary; past performance does not guarantee future results. 6 London Bullion Market Association; gold fixing pricing at 3 p.m. London time; Prices can and do vary; past performance does not guarantee future results.

8 It is important that you do not use this publication to request or authorize the purchase or sale of any security or commodity, or to request any other transactions. Any such request, orders or instructions will not be accepted and will not be processed. All items discussed in this report are for informational purposes only, are not advice of any kind, and are not intended as a solicitation to buy, hold, or sell any securities. Nothing contained herein constitutes tax, legal, insurance, or investment advice. DISCLOSURE: Investing involves risk including the potential loss of principal. No strategy can assure success or protects against loss. Past performance is no guarantee of future results. Asset allocation does not ensure a profit or protect against loss. There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non- diversified portfolio. Diversification does not protect against market risk. Please note that rebalancing investments may cause investors to incur transaction costs and, when rebalancing a non- retirement account, taxable events will be created that may increase your tax liability. Rebalancing a portfolio cannot assure a profit or protect against a loss in any given market environment. Fixed income investments are subject to various risks including changes in interest rates, credit quality, inflation risk, market valuations, prepayments, corporate events, tax ramifications and other factors. Non- U.S. securities markets involve possibly greater risk of political instability and greater currency risk in addition to having been more volatile. These risks can be accentuated in emerging markets. Commodities investments are speculative and involve special risks related to weather and international political and economic developments. Equity investments tend to be volatile and do not involve the guarantees associated with holding a bond to maturity. Alternative investments may not be suitable for all investors and should be considered as an investment for the risk capital portion of the portfolio. Tactical allocation may involve more frequent buying and selling of assets and will tend to general higher transaction cost. Investors should consider the tax consequences of moving positions more frequently. Beta measures a portfolio s volatility relative to its benchmark. A Beta greater than 1 suggests the portfolio has historically been more volatile than its benchmark. A Beta less than 1 suggests the portfolio has historically been less volatile than its benchmark. Past performance is not a guarantee of future performance. Different investments involve different degrees of risk, and there can be no assurance that the future performance of any investment, security, commodity or investment strategy that is referenced will be profitable or be suitable for your portfolio. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. The information contained in this report does not purport to be a complete description of the securities, markets, or developments referred to in this material. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. Before making any investments or making any type of investment decision, please consult with your financial advisor and determine how a security may fit into your investment portfolio, how a decision may affect your financial position and how it may impact your financial goals. All opinions are subject to change without notice in response to changing market and/or economic conditions Copyright 2016 Financial Jumble, LLC Blue Ocean Global Wealth All rights reserved.