After an impressive multi-year advance beginning in 2009, US and global financial markets were unable to make any gains in 2015 year to date.
Global deflation, caused primarily by the ongoing collapse in energy and other commodities prices, along with stagnant US corporate industrial earnings, a rather poor retail environment and other negative macro-factors all placed continuing pressure on financial asset prices throughout the year.
Though the popular averages such as the S&P 500 and Dow Industrials were down slightly year to date, the average stock in the indexes was down substantially. High gradebond prices gyrated in a narrow range, but with ended up little net change. Only a handful of high-flying stock names such as Amazon, Nike and Google propped up the averages while most stocks were lower for the year. Of particular concern recently is the deteriorating situation in the low grade “high yield (junk) bond markets, where prices have fallen sharply, causing many investors in that sector to liquidate other, better quality assets to cover their losses.
These results could leave us to conclude that US stocks are getting cheap, since most stock names went backward this year, but such is not really the case, as the S&P 500 Price Earnings ratio is still at a fully priced value of around 17. This was the result of rather poor earnings results (the “E” in P/E) from several industry sectors such as energy, metals, retail, apparel, rail transports, machine manufacturing, materials and several others.
During 2015, the global economy was unable to produce any material growth, while major national economies, such as in Russia, Canada and Brazil went into recession. China, the world’s second largest economy has slowed significantly, resulting in a deflationary environment that has pressured economic growth prospects everywhere. The world has simply produced more goods and services than global households and corporations can buy; a classic overcapacity dilemma and the hallmark of a deflation that can lead to recession.
Meanwhile, economic results in Western Europe are showing signs of improvement, as monetary stimulus from the ECB (European Central Bank)has underwritten some nascent growth; but much more expansion is needed before Europe can be seen as a lasting growth opportunity. On December 16th, the US Federal Reserve raised short term interest rates to 0.25%, the first increase since 2006. This was seen as an indication that the Fed sees the US economy as healthy enough to begin normalizing interest rates.
Not all the 2015 news was negative. The once beleaguered automobile sector was quite strong, with the Detroit motor companies reporting record vehicle sales as car buyers took advantage of easy credit and lease terms. Auto parts earnings were also quite positive. Pharmaceuticals and Biotech continued to advance, though pricing pressure from certain politicians may present a problem for some of these high quality companies. Housing continued to improve as well, as home prices continued to gain, while multifamily construction was quite strong in several US regions.
Considering how choppy and treacherous markets have been in 2015, our approximate break-even investment results should be seen as quite satisfactory, as many other investors, particularly certain leveraged investment managers, mutual funds, hedge funds, private investors and high yield junk bond holders suffered heavy losses this year.
Outlook for 2016:
Risks of an economic recession in the US are increasing.. The current consensus of economists is looking for modest GDP growth for 2016, but that is subject to change. Certain key economic indicators have been signaling weakness for much of this year. Employment figures have been generally good, but below average for the current stage of this economic expansion, while business in manufacturing, mining, metals, rail transports and especially energy are already operating under recessionary conditions. If energy, metals and other commodities can bottom in 2016, we may see a recovery and a positive year, so it is important to avoid being overly pessimistic.
Investment Plan for 2016:
While there is no major change to our long-standing conservative, Total-Return policy, a partial rebalancing toward dividend paying, lower volatility investments is in order. We will be partially deemphasizing growth investments and making additions to the stable and strong dividend names we hold, such as Verizon, Proctor & Gamble, Johnson & Johnson and some defense and aerospace names such as Boeing, Raytheon, Northrop-Grumman and Lockheed-Martin. These investments offer stability, good dividends and growth possibility. High grade bonds, with the exception of the high quality tax exempt municipals, remain too expensive to add to portfolios.
The coming year can be one of recovery or recession; with not much prospect of the easy gains we’ve seen in previous years.