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2015 Q4 Market Review: A Churning Market that ends with a Whimper

This is our fourth quarterly review of the markets for 2015. As you know, we do not believe in making forecasts, but we comment on cross currents influencing the markets. As usual, our goal is to look at recent market results, put them in perspective, and see how that experience should set our expectations going forward. We will also take a peek at the market’s strong decline as we begin 2016.

Since so much is happening in the markets, please bear with the length of this month’s post. We look at the following topics:

  • 2015 Q4 Markets Review
    • Summary of Returns
    • Factors Influencing Performance
  • What Does all This Mean?
    • Emotional vs. Disciplined Investing
    • 2016: A Look Ahead
  • Conclusion

2015 Q4 Market Review

Summary of Returns

Some of us were glad to say goodbye to 2015 by the time we concluded the fourth quarter. Volatility had increased, and both the stock and bond markets churned. While the fourth quarter brought some relief, most asset classes provided negative returns for the year, although some fared much better than others:

  • Stocks were down for the year, although growth stocks did far better than value stocks (a great case for a diversified strategy). Large companies also did better than small companies.
  • US stocks did far better than non-US stocks. Emerging markets had a very rough time.
  • Bonds, after hanging in there for much of the year, ended 2015 down.
  • Real estate investment trusts (REITs), particularly those in the US, held up well.
  • Master limited partnerships did terribly, declining with oil prices
  • Commodities besides oil also slid, but gold held up relatively well. It is beginning to perk up with a growing perception that the Fed may be on hold for a rate increase.
Market Returns
Market Index September Q4 2015 2015
Large Cap S&P 500 Index -1.6% 7.0% 1.4%
Midcap S&P Midcap -4.2 2.6 -2.2
Small Cap S&P Small Cap -4.8 3.7 -2.0
Non-US Developed Markets MSCI EAFE -1.4 4.7 -0.8
Emerging Markets MSCI Emerging Mkts. -2.2 0.7 -14.9
US Bonds Barclays US Aggregate -1.2 -0.7 -4.6
REITs S&P US REIT 1.8 7.0 2.5
MLPs Alerian MLP -3.6 -2.8 -32.6
Gold Dow Jones-UBS Gold Sub index Total Return -0.5 -5.0 -10.1
Commodities Dow Jones-UBS Commodity Index TR -3.5 -11.4 -25.3

Sources: AJO Partners, Factset, Dow Jones Indexes

Factors Influencing Performance

The table just presented does not address all the winners and losers within the stock market. Technology, health care, and consumer-driven issues posted modest gains (Bloomberg), the relentless drop in commodity prices hit the mining and energy sectors hard, large companies beat smaller companies, and U.S. stocks generally topped international.

Meanwhile, longer-term Treasuries yields continue to hold near historic lows, which signaled there’s still plenty of interest in the most creditworthy bonds. Ultra-low government bond yields in Europe (Bloomberg) may be driving overseas investors to our market who are seeking both a relative degree of safety and higher returns. Or, expectations that U.S. growth and inflation won’t significantly accelerate may also be keeping investors engaged in Treasuries.

We did, however, see a modest increase in bond yields (and corresponding decrease in price) among investment grade issues (as measured by the BofA Merrill Lynch US Corporate Master Effective Yield—St. Louis Federal Reserve) and bigger problems in high-yield bonds, sometimes called junk bonds. Expectations of an eventual Fed rate hike probably influenced yields in investment grade issues. But the sharp increase in junk bond yields, especially those with the lowest credit ratings–were tied mostly to problems in the energy and mining sectors.

What Does All This Mean?

Emotional vs. disciplined investing

Luckily, clients of mine have stock allocations that are reasonable in light of your financial capacity and your tolerance for risk. So the fact that volatility has returned to the stock market should not be cause for alarm. During the year, those of you with higher stock allocations than indicated as appropriate had your stock positions decreased, in some cases significantly. But this was not a market timing move. We are really just managing to a particular risk target for your portfolio, which should be as risky as you can handle in the worst of markets, and no more.

As we’ve discussed in our face-to-face meetings, your personal situation, goals, and risk tolerance influence your investment plan. If your personal situation has changed, we may want to make a mid-course adjustment to your investment portfolio.

But for many investors, the plan that was designed specifically for you remains the best long-term roadmap.

If we instead react emotionally, let’s take a look at the damage that can happen. We would like to highlight a study published last year by DALBAR, one of the nation’s leading financial research firms and one with a 40-year track record.

The study found that over a 20-year period ending December 31, 2014, the average equity stock fund investor posted an average annual return of 5.19%, which compares unfavorably to the average annual return for the S&P 500 Index of 9.85%.

Going back 30-years, DALBAR paints an even gloomier picture, with the average equity stock fund investor earning 3.79% annually versus the S&P 500’s average annual gain of 11.06%.

As the study underscores, “Investor underperformance is present in all investment classes, therefore proving (the word it used in the study) that the failure is not primarily one of poor asset allocation.”

My goal has never been to match or outperform the S&P 500 Index. Instead, my job is to design a portfolio that fits your financial and life circumstances. An all-stock portfolio, even one that is fully diversified, is too risky for most investors. I typically recommend a fixed-income component that not only reduces overall volatility but creates a steady stream of income.

So what may be the causes of such woeful underperformance?

Some simply has to do with everyday cash needs and unplanned expenses. But the study concluded that the largest contributor came under what it called “voluntary investor behavior,” which generally represents “panic selling, excessively exuberant buying, and attempts at market timing.”

Prudential took the study one step further and analyzed equity cash inflows and outflows over the last 20 years ending December 31, 2014.

Not surprisingly, investor interest was the highest when shares peaked in 2000 and outflows were largest when prices approached the bottoms in 2002 and 2009.

It’s what happens when emotions get in the way of a disciplined approach.

Honestly, I get it. There is a temptation to sell when stocks are in downdraft, as we briefly saw last year. But as I have repeatedly stressed, your financial plan takes into account those hard-to-time downturns, which leaves us well positioned when shares inevitably move higher.

2016: A Look Ahead

The market has started off poorly already this year. We expect continued volatility as the markets try to assess the direction of the world economy. There are several contributing factors.

Non-US Markets

Last year, international events played a role in hampering sentiment at home. A slowing economy in China provided just the right excuse for late summer’s correction. Those concerns have continued into 2016. While those concerns may already be priced into the market, it still is not clear whether China will have a hard or soft landing with its economy. While its stock market is small, it is a large world economy, and hence the market’s focus on China.

Let’s not forget Europe. Greece may have settled down, although we may not have heard the last; eurozone leaders appear to have created a financial firewall that is strong enough to contain the fallout if Greece defaults this year. But other issues have emerged, with political uncertainty on the continent and a wave of immigrants from the Middle East creating challenges that must be addressed.

Manufacturing Woes and Oil

Closer to home, the U.S. service sector has continued to expand at a moderate pace, but manufacturing remains in the doldrums. Manufacturing accounts for a small segment of the U.S. economy. But a healthier industrial economy would likely create a favorable tailwind for stocks.

As we enter the New Year, two stiff headwinds remain–oil and a stronger dollar that is contributing to weakness in exports.

Many of us are being treated to the lowest gasoline prices in years.  But consumers are benefiting at the expense of producers, and not just the big oil companies. Sharp cutbacks in capital spending in the energy sector, coupled with layoffs, are hampering manufacturing.

Junk Bonds–Junkier or Better Values?

The well-documented problems in energy and mining have spilled over into high-yield bonds. Moreover, the riskiest bonds, or those which sport the lowest ratings, have seen the largest jump in bond yields.

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 as the New Year begins (St. Louis Federal Reserve).

If oil and the commodity sector begin to bottom and the economy continues to expand at a modest pace, much of the damage in junk bonds may be behind us.

While the jury it still out, a Fed policy that encouraged very low interest rates, which in turn, encouraged a reach for yield by investors, may have created too much enthusiasm for high-yield debt over the last couple of years.

Seeking Clarity in Corporate Earnings

Corporate earnings are probably the most important variable in determining the direction of stocks over the medium and long term. Yes, other factors can create volatility shorter term, but profits are the lifeblood of stocks.

According to Thomson Reuters, earnings for S&P 500 firms collectively fell by 0.8% in Q3 and are forecast to decline 3.7% in Q4. Much of the weakness can be pinned on a steep drop in earnings among energy companies.

Pull out the energy sector and Q3 profits would have been about seven percentage points higher, according to FactSet Research.

The rise in the dollar has also weighed on profits of multinationals, as they translate sales abroad back into the stronger greenback.

But Thomson Reuters is projecting that earnings will begin rising again in the first quarter of 2016 and accelerate in Q2 and Q3.

Of course, what happens to energy, the dollar, and the economy will ultimately determine the path of corporate earnings. But the forecast for an improving profit outlook, which may not be fully priced into stocks, could give rise to cautious optimism as 2016 begins to unfold.  While there are always many possible scenarios for the year, one is that the market is rocky while it continues to sort out the economic risks mentioned earlier. Eventually, should corporate earnings deliver, it would go a long way toward restoring confidence.


We are off to a volatile start to 2016, so strap on your seat belts. Please make sure you are at your recommended risk level and asset allocation for your portfolio. If you are, then all is well, and you can focus your attention elsewhere. If not, please make adjustments so that you are. And last but not least, if you are not sure, please call and let’s see where you need to be.

By all means, once your risk level is where it should be, do not look at your account balances daily and calculate your paper losses. I frequently hear comments like “in the last three months, my 401(k) has lost $XX thousand.” I have several responses. One is that it is a paper loss. Second is that this is only a problem if you have a short term need for the money; in another 25 years you won’t even remember that this happened, but you will appreciate the growth and dividends that stocks can provide. And last, markets are always shifting. You can say such things at various points in time, depending on when you look. Please think and act longer term.

All of this assumes that you separate your short term cash needs from your longer term investment portfolio. Please do not mix the two, even if you feel that returns on cash are poor. If you need the money in less than five years, it really does not belong in anything riskier than a short term bond fund.

I always emphasize that as your financial advisor, it is my job to partner with you. If you ever have any questions about what I’ve conveyed in this month’s message or want to discuss anything else, please feel free to reach out to me.