The fed finally got a backbone and adopted their monumental 25 basis-point interest rate increase, one that they had been telegraphing to markets for over a year. Liftoff has occurred. Now what? Financial markets took the news, as most expected, a big “Ho-Hum” of sorts. Credit markets did not come unglued, nor was a liquidity crunch visible. The U.S. dollar barely budged, and the Sun did come up again in the morning. We can live another day.
There was no proverbial straw breaking the camel’s back, but that has not kept the doomsayers at bay. Their dam has broken on all manner of gloomy predictions related to China, oil and commodity prices, the strength of the U.S. dollar, earning forecasts for 2016, and you name it. The Bears have made a mad grab for the headlines, while the Bulls are busy celebrating the holidays and waiting for the greatly anticipated “Santa rally”. This is the one time of the year when things do slow down. Tax planning is now of the essence, as is cleaning up portfolios to look their best at year and quarter end.
As the New Year quickly approaches, it is also appropriate to look back, to see what transpired in the previous year, and to reconcile why mistakes were made and relish where success was actually achieved. 2015 was not a good year for investment managers. The so-called “sure bets” were anything but, and as Richard Freeman, portfolio manager at the $104 billion fund firm ClearBridge Investments, put it, “We’ve had simultaneous bull and bear markets in the same year in different stocks and sectors, more than I can remember in quite some time.”
What were the major mistakes in judgment that plagued CY 2015?
For the moment, the S&P 500 index is just a few percentage points below breakeven for the year, but a small “Santa rally” over the remainder of the year could drive the annual result into positive territory. Investors that chose to concentrate in technology, health-care, and biotechnology offerings were rewarded, but if you had followed the herd into financial, energy-related, and consumer-based stocks, then you would have felt the pain. Here is a brief recap of why the pain originated in the first place:
- Banking Sector: At the start of 2015, everyone and their Grandmother expected the Fed to begin ratcheting up interest rates. The U.S. dollar went on a strengthening binge in anticipation of this move, draining emerging markets of much needed capital and threatening to upset the export applecart of the U.S. economy. Fed governors in various speeches had pegged June as the likely beginning of “normalization”, as they named the process. Fed rate changes would easily translate into wider spreads and more profits for banks, a “sure thing”, if ever there was one. NOT! The Fed dragged its feet, let them get cold, and did not act until December. Perhaps, stocks for banks, insurance companies, and other financial entities will rally in 2016, but for the current year, investors can only lick their wounds;
- Energy Sector: Oil and other commodities had taken a beating in 2014, but experts predicted a quick bottoming out and a year of recovery in 2015. NOT! As the greenback appreciated, commodities took a double hit. Commodity prices are stated in dollars, thereby making them more expensive with each tick up in the USD, and, as China turned off its internal infrastructure building splurge, commodity producers were forced to face the reality of deflation. Demand quickly plummeted. Supply inventories shot through the roof, as prices went into a death spiral. Emerging markets dependent on this sector saw their economies decimated and external capital withdrawn. Oil may have garnered most of the headlines, but the impacts were felt across the board. Prices for crude fell more than 35% for the year, with similar results for copper, steel, and other basic resources. As for the entire sector, one analyst noted that, “The S&P 500 energy-sector index is down 25% this year.”
- Consumer Sector: If ever there was to be a year where restaurants and retailers were to be the leaders of the market, then 2015 was to be it. Low oil and gas prices would surely bloat the wallets of all consumers and create a headlong rush for the malls to spread the wealth. NOT! One investment management CEO, Craig Hodges, opined, “There’s no question there’s been a lot of disappointment among the restaurants and retailers. It’s a little bit of a head-scratcher. What are consumers doing with their money?” The so-called windfall of lower gasoline prices never created the avalanche of consumer spending that was thought to be another “sure thing”. Recent studies have confirmed that roughly 25% of the oil-related largesse did flow into retail oriented businesses, but the continuing problem has been that Americans must still come to terms with a mountain of debt, as do banks, that has been amassed over the previous decades. The other 75% of the new found funds went to servicing this debt and building a savings safety net for the next business down cycle.
The road to recovery has been a rocky one, and continued uncertainty about the coming year is not helping. The recent rollercoaster ride of the S&P 500 index is but one example. During the first six months of 2015, this popular index recorded no less than ten new record highs, but the second half of the year has been a completely different story. Wide up and down swings became the new normal. Time-honored correlations in the foreign exchange market were cast aside. The actions of central bankers were overly influencing market behavior, creating a wobbling house of cards that could fall at any moment. 2015 will go down as the year when the most popular bets went up in flames.
What are the major concerns as we head into a new calendar year – 2016?
As we head into 2016, there are four continuing issues that will bleed into the coming year, two being in the major category, while the other two add to the headwinds that must be overcome, if there is to be improvement year over year. These are the overriding concerns going forward:
1) U.S. Dollar Strength: Since May of last year, King Dollar has forcefully regained its rightful position atop the throne of currencies, appreciating more than 25% over the period. Will there be more? Most analysts expect a decline, but the timing is questionable. Economic havoc has already been wreaked upon commodities and emerging markets. Less will be more;
2) Commodity Prices: By some estimates, China had been consuming more than half of the world’s resources on an annual basis, until demand from the West began to recede a few years back. Oversupply is now the reality in all sectors, and a firm bottom has yet to form. The road to recovery will be slow;
3) China: The situation in China is not improving. Official proclamations are more often suspect than not, but the most recent China Beige Book's survey of thousands of companies, one source of reliability, tells a story “of pervasive weakness, national sales revenue, volumes, output, prices, profits, hiring, borrowing, and capital expenditure all weaker on-quarter.” Stimulus programs on all fronts are not working. Economic reforms will take time;
4) Europe: Sovereign debt issues will come under pressure again, as default looms on each horizon. Most experts believe that Mario Draghi, the head of the ECB, has run out of central banking tricks to stimulate growth. Inflation is near zero, as is GDP growth. Major structural reforms have languished, since the present system does not allow for political clout. The local crisis will drag on, as will the rhetoric.
Each of these concerns will impact both global and domestic economies in the months ahead. As a result, corporate earnings will be subject to their whims. The best benchmark for measuring this combined global impact will be the S&P 500 index, since participating companies earn roughly half of their revenue from sales overseas or from overseas operations. So goes the S&P 500 index, then so goes the global economy and forex markets, for that matter.
Forecasters were correct in one of their predictions for 2015 – year-over-year earnings did decline over the four quarters of this year. What is the guess for 2016? Analysts at J.P. Morgan Chase and Bank of America Merrill Lynch have each set a target for the S&P 500 of 2200 by the end of 2016, each believing that corporate earnings will rebound in the ensuing twelve months. Based on today’s value of 2036, these experts foresee an 8% pickup in valuations, driven by improving earnings. Place your sector bets carefully.
Are we staring at recession possibilities in the midst of this presidential election year? Prior statistics do not support that grim a future, but even the most optimistic predictions indicate a 5% probability that an economic reversal is not out of the question. One analyst, in search of the prize for “Best Chart of the Month”, has strongly suggested that the following chart, along with a few others, scream that the current Bull market is DOA:
As he notes, “This chart shows that after a long run of record profits, the inevitable business cycle is turning over and profit margins are beginning to collapse. 1985 marks the only time when a 60 basis-point contraction in profit margins did not precede an economic recession. This indicator has a high correlation indicating coming market and economic turmoil.” Other experts are not convinced. The jury is still out.
Concluding Remarks
2015 was not a year to have shared in a herd mentality. Popular bets soon turned into debacles. The forecasters did enumerate the major concerns for the year, but their ability to assess inter-relationships and related timing issues failed them. Bank forex analysts were correct on one score. The USD Index started the year out at just above 90, and nearly every expert pointed to 100 as the most appropriate yearend forecast. The dollar has been hovering around this value for weeks.
A strong dollar, however, will crimp U.S. trade and commodity prices, until an inevitable weakening occurs. Once again, timing will be the overriding factor. Combine that timing with the Fed and interest rate normalization, along with presidential politics, and you have a mixed bag for 2016 on all fronts. With uncertainty, however, comes chaos and opportunity for those with a penchant for trading. Keep your powder dry and have your strategies already well thought out. The potential for gains in 2016 should not disappoint.
Risk Statement: Trading Foreign Exchange on margin carries a high level of risk and may not be suitable for all investors. The possibility exists that you could lose more than your initial deposit. The high degree of leverage can work against you as well as for you.