2015 was a tough year for the stock market, especially for investors who relied on fundamental value. Apart from a handful of high growth stocks which helped the overall S & P 500 index, the average stock in the index was down almost 4 %. The small caps and international stocks were down approximately 5%. The declines were significantly worse when compared to the highs in May. The classic value investor, Warren Buffet, saw his stock decline over 11%! The so-called smart money or hedge funds saw their value decline in the single digits (average) with many funds falling by double digits. Safe havens such as gold were down about 11% and cash returned essentially 0%. Many investors pulled back because of fears of rising interest rates, the Chinese economy, falling commodity prices (which affect the energy sector and credit markets), and concerns of the aging bull market. So where does this leave us going into 2016?
I expect that many of the same themes of 2015 will carry though to 2016 but the outcome in the market may be different. Some of the concerns about rapidly rising interest rates will probable abate as the Federal Reserve will be cautious about going too fast on increasing the Fed Funds Rate and inflation will probably stay low. China will continue to throw money (which it has in excess) at its slow growth problem as it tries to convert from more of an export economy to more of a consumer oriented economy. Although almost everyone would like to see a faster growing U.S. economy, slow growth is generally good for the stock market because it keeps inflation and bond yields low. I believe the single biggest factor in the overall market performance is the price of commodities, particularly oil. Although benefiting the consumer, low crude oil prices affect the profits and even the financial stability of most the energy companies. Once oil prices rise enough to take the financial pressure off the energy sector, the rest of the market will be able to focus on the profit of non-energy companies which increased over 6% this year. The average prediction of many Wall Street sages is that the market will be up 7 % in 2016 (USA Today Dec 31, 2015). This forecast fits nicely with a broad market increase profit of 5% and a dividend yield of 2%.
Bond returns will probably continue to be minimal because of low yields and most likely falling prices. High quality municipal bonds may be the safest bond play for the investor in a higher tax bracket (in a taxable account). High-yield bonds which were beaten down this year may be a value play for investors with a high-risk tolerance.
You may have heard of an increasing number of pundits that are predicting a stock market collapse. A sustained bear market generally does not occur in the absence of a recession. Although no one can predict a “black swan” event, the slow expansion over the last six years makes it more likely that there is still legs left in the slowly expanding economy. That being said, it is always prudent to keep a few years of cash needs in assets that are not tied directly to market performance
Over the last three years, growth stocks have outperformed value stocks (long term the opposite is true). While the old Wall Street saying the “trend is your friend”, I look for a resurgence in value/dividend paying stocks. Either way, I believe that stocks will be the investment of choice for those looking to get the best return over the next 10 years and are not bothered by the usual volatility. My prediction is that a diversified stock portfolio will return around an average of 6% net of fees and expenses.
The above predictions represent the opinion of John Quimjian, registered investment advisor representative. Written Mar 7, 2016.