2015 was an eventful year in the financial markets. The first half of the year looked as if the bull market would continue with most stock indices up, both foreign and domestic. Diversification across different asset classes, which is primarily a risk reduction strategy, also benefitted portfolios for the first time in several years as indicated by increased returns. However, in the 3rd quarter, markets turned decidedly negative as overall investor sentiment seemed to switch to a “glass half empty” mentality. While there was a bit of a rebound in the 4th quarter, the general temperament of the markets has remained subdued.
We find it helpful to look back to this time last year to see where we came from, what we were anticipating, and how things played out. While 2014 was following an extraordinary year for the stock markets, 2015 followed a lackluster year where only a few industries propelled the U.S. stock indexes into a positive range. 2015 was also on the heels of a massive upward move in the U.S. dollar which served as a headwind to U.S. companies with global footprints. While oil prices had started their decline in 2014, this was not a major headline that the decline might be temporary, unfortunately that was not the case in 2015.
The apparent major themes that drove markets in 2015 were: China’s slowing economy, low oil prices, and the Federal Reserve raising rates. I would add to that list, the strong dollar, as its implications continue to impact markets.
China’s economy is slowing, which should not be a surprise to most, but it had a chilling impact on markets in 2015 and is back in the headlines today. The hopeful side is that much of the slowing is purposeful by the government to diversify their economy away from heavy manufacturing, and if China continues to grow at 6-7% (GDP) this should still be a powerful engine for global growth. Low oil prices surprised many in 2015 and it seems that everything “bad” for the U.S. oil industry that could happen, happened this year; Iranian’s can now export oil, OPEC and Russia have not cut production, storage capacity is filling up, and a strong dollar have helped push prices lower. However, the cost of producing oil in many cases is higher than current prices, it seems there is almost no “risk premium” being assigned to oil prices despite a turbulent Middle East, and we all still need oil. These factors are typically a recipe for oil prices to rise at some point, just maybe not quickly. Low oil has had a tremendous impact on investor sentiment. Investors have seemingly fled emerging markets, high yield bonds, and energy companies specifically. The longer this goes, the more investors may start differentiating assets that are truly at risk and those that aren’t.
Pessimism is a powerful force, but it should not be blinding. Many investors think that current circumstances are permanent, but this is rarely the case, which should give rise to hope that oil could stabilize and even rise in the future. The U.S. dollar is intertwined into all these themes. The dollar has surged three different times in the past 45 years, in the 80’s (61%), in the late 90’s (42%), and since 2010 (now ~38%). This most recent gain of 20+% from mid- 2014 to mid-2015 is the largest dollar increase since the dollar went off the gold standard in the early 1970’s. While there may be some continued strengthening, we are hopeful that the dollar may start to stabilize in 2016 as investors review central bank policies and economic results.
Lastly, and maybe the headline of the year, is that the Federal Reserve has raised interest rates for the first time in nearly 10 years. This is an apparent vote of confidence by the Fed that the economy is strong enough to withstand higher rates and a move towards rate normalization as the unemployment rate and inflation are “close” to targets set by the Fed. The Fed has telegraphed that it hopes to move rates more in 2016, but most feel that the pace will be slow and the ultimate stopping point still remains at below historical levels. The real question seemingly in many investor’s minds is whether or not the economy will sputter and require a rate cut, or simply absorb the hike and proceed as hoped. Without a doubt, rate increases are major events and market volatility should continue to be a theme in 2016.
What are we to do with portfolios in 2016? We believe strongly that portfolio returns over time are the result of 4 P’s: Philosophy, People, Process, and Patience.
Our Philosophy is built on a risk-based approach to valuing assets and projecting long-term returns. We know that this doesn’t work in every single short time period, as quite honestly, nothing works in every short time period. However, the basis for assets to grow at their long-term expected returns relies far more on economics and fundamentals than simply hope or being smart enough to pick winners and losers.
Our People encompasses both our Investment Committee at Bridgeworth as well as our many research partners who help do the hard work of analyzing the things that matter. In the short-run the “voting machine” of the market is determined by the emotions of participants. Predicting and following emotions can be a pretty unfruitful investment strategy, so we seek to avoid it and focus on fundamentals.
Our Process is one of putting together the combined knowledge of different assets into a portfolio that is designed to meet a specific objective. It does not rely heavily on the skill of one person or ability to time the market, rather to overweight assets with the greatest potential for growth given a level of risk.
Finally, and probably the most difficult of all is Patience. At Bridgeworth, many of us eat, drink, and sleep investments, so hopefully you don’t have to. A year, or two, often feels like eternity when you aim to make decisions that affect your wealth and ultimately your goals. However, investing is unlike other disciplines in which one participates. A year or two is very short and investment fundamentals like diversification, “buying low” and “selling high”, rebalancing to maintain a risk profile, and avoiding chasing returns are not new and are not broken just because they don’t work in that time frame. The challenge is to apply them consistently over long time frames and be patient. If we jump from one grocery line to another because ours isn’t moving, we may be more susceptible to poor results. There is a concept in investing called “reversion to the mean,” which simply means that anything that outperforms significantly will eventually have lower performance to bring the return back to a more normal (“average”) level. Likewise, if something performs very poorly it often will “revert” back up to the “mean” or average. Reversion to the mean is sort of a gravity that seems to exist in many things, even weather, sports, etc. The point is that when fundamentals like diversification haven’t worked for a while, it is our belief that we are closer to that reversion taking place and we will be patient. If we implement all the other steps but do not exercise patience we will most likely miss the benefits.
We thank you for your trust and patience in these volatile times, as we take our role as stewards of your wealth very seriously. A New Year is always a time of great hope and there are many wonderful things to be both thankful and hopeful about. The investment markets are one place that hope springs eternal, as the world’s entrepreneurs and workers strive to make the world a better place with new inventions, cures, technologies, and services. Despite our negative news media, we are hopeful for the future and believe that prudent management and planning can help make you and your family’s futures a better one as well.
Happy New Year!
Zach Ivey, CFA, CFP®
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual security. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results. Indexes are unmanaged and cannot be invested into directly.
Economic forecasts set forth may not develop as predicted.
Investing in stock includes numerous specific risks including: the fluctuation of dividend, loss of principal, and potential liquidity of the investment in a falling market.
Because of its narrow focus, specialty sector investing, such as healthcare, financials or energy, will be subject to greater volatility than investing more broadly across many sectors and companies.
Investing in foreign and emerging markets securities involves special additional risks. These risks include, but are not limited to, currency risk, geopolitical risk, and risk associated with varying accounting standards. Investing in emerging markets may accentuate these risks.
Bonds are subject to market and interest rate risk if sold prior to maturity. Bond and bond mutual fund values and yields will decline as interest rates rise and bonds are subject to availability and change in price.
Commodity-linked investments may be more volatile and less liquid than the underlying instruments or measures, and their value may be affected by the performance of the overall commodities baskets as well as weather, geopolitical events, and regulatory developments.
Bridgeworth, LLC is a Registered Investment Adviser.