2016 Q1 Market Commentary

As we begin each New Year, it is good to reflect on the year that just ended and what we may have learned from it. Here are some thoughts about the market activity we saw in 2015, and what we may see in 2016.

After a volatile third quarter, the S&P 500, an index used to track the U.S. stock market, was in marginally positive year-to-date territory at the end of November. Then in December it lost nearly 2% to finish the year down 0.73%, its first negative year since 2008. After accounting for dividends and their reinvestment, the index generated a total return of 1.4%, marking its lowest return since 2002, excluding the 2008 financial crisis. Following five consecutive years of steady earnings-per-share growth, an indicator of corporate profitability, companies comprising the S&P 500 leveled off in 2015, finishing slightly lower than a year earlier. This indicates growth in corporate profits began to stall during the year. International developed markets performed slightly better than U.S. markets in local terms, but the rising dollar resulted in a negative return for U.S. investors. Emerging markets were down 8% in local terms, and the strong dollar added to the losses for investors in the U.S.

Investors have spent years fretting about an impending interest rate hike because higher rates tend to cause the price of bonds to fall. D-Day finally arrived for bond investors on December 16 when the Federal Reserve announced the first increase to short term interest rates in nearly a decade. As was widely expected, the Federal Open Market Committee, the Federal Reserve’s monetary policy setting arm, raised the target for its key Fed Funds rate from 0.00%-0.25%, where it had been since late 2008, to 0.25%-0.50%. The Fed suggested that it will raise the rate modestly several more times this year. Many traditional bond funds did turn in losses for 2015, but they were modest and in many cases will be made up by increased interest rates in short order.

So, what caused all of this? Four macroeconomic factors cast a big shadow over the markets in 2015: (1) uncertainty about the timing of the interest rate increase by the Fed that finally materialized in December, (2) the impact on corporate profits from oil prices that fell by over 30%, (3) a rising U.S. dollar, and (4) questions about growth in China.

• As we’ve discussed in prior commentaries, investment markets hate uncertainty. We saw this as the market gyrated in anticipation of every Fed rate announcement over the past year.
• The energy sector saw a sharp drop in profits as a result of the decline in oil prices, with share prices in the sector falling by 26%.
• The stronger dollar hurt corporate profits in two ways: First, companies relying on exports were challenged as the cost of their goods increased in foreign markets. Second, for multinationals the rise in the dollar led to a decline in the value of profits in their overseas subsidiaries.
• Finally, we come to China. Our prior commentary covered this in more detail, so we won’t spend much time on it here. As the world’s second largest economy there is concern about a global slowdown triggered by a decline in Chinese demand. The saying goes, “When China sneezes the world could catch a cold.” Sharp drops in the Chinese markets resulted in a domino effect, causing worldwide market declines at the start of 2016.

We did see one bright area in the US markets, which largely offset the weakness in energy. This came from what Wall Street has taken to calling the FANG stocks: Facebook, Amazon.com, Netflix, and Google (recently renamed Alphabet). These stocks produced returns ranging from 178% for Amazon.com to 34% for Facebook. These four stocks account for almost 9% of the S&P 500; remove their positive contribution to returns and you are left with a very different picture for the year.

This year, 2016, should similarly prove interesting, if for no other reason than the presidential election. A look at past election years reveals increased volatility as the polls show which candidate is in the lead. As previously mentioned, markets hate uncertainty. In a capitalist economy such as ours, the markets tend not to care which party is in office; rather, they dislike the uncertainty of not knowing who may soon be elected. Once the election is over, we can expect to see some of the volatility subside as the markets adjust to the new political regime. China will continue to drive market volatility in the short run. Last, but not least, Saudi Arabia is not giving any indication of supporting oil prices. Instead, they are keeping prices low to gain market share, a strategy that appears to be working as American producers are driven out of production. This will lead to continuing weakness in sectors of the U.S. market dependent on oil production. However, as these producers exit the market we will see demand begin to outpace supply and oil prices should rise.

It is important to remember that volatility and market declines are normal. We have not experienced a 15% decline in 1500 days, historically drops of this magnitude occur every 300 days. This prolonged period of low volatility lulls us into a sense of complacency, making a return of volatility seem worse than it really is. Similarly, we experience losses in the U.S. stock market every five to eight years. 2016 marks eight years since the financial crisis and great recession, so we are due for a down year. During uncertain times such as these, the discipline to follow an investment strategy and maintain diversification must be reiterated.

The views and opinions expressed are of Persium Advisors, LLC. This commentary is provided for educational purposes only and should not be construed as investment advice. Persium Advisors is an investment advisor firm located in Atlanta, GA.