January 25th, 2016
2015 Fourth Quarter and Year End Report
In the year just past, we experienced many things—a prelude to a presidential election, a renewal of terrorist concerns, and wild weather patterns. In the investment markets, despite some entertaining ups and downs, the markets ended pretty much where they began, eking out small gains and losses pretty much across the board.
The final three months of the year provided U.S. investors with gains that were tantalizingly close to wiping out the losses of the third quarter. The widely-quoted S&P 500 index of large company stocks was up 6.45 percent in the fourth quarter, but finished down -0.73 percent for all of 2015—its first yearly loss since 2008. The Russell Midcap Index lost -2.44 percent in calendar 2015.
This was a year to forget for investors in small company stocks. As measured by the Wilshire U.S. Small-Cap index, investors posted a small 2.62 percent gain over the last three months of the year, but in the end the index had lost -4.86 percent over the entire 12 months, dragging many diversified portfolios into negative territory. The comparable Russell 2000 Small-Cap Index finished the forgettable year down -4.41 percent.
International investments caused a decline to overall portfolio returns. The broad-based EAFE index of companies in developed foreign economies gained 4.37 percent in the fourth quarter of the year, but finished the year down -3.30 percent in dollar terms. Emerging markets stocks of less developed countries, as represented by the EAFE EM index, lost -16.96 percent for the year.
Meanwhile, bond investors started the year—as in years past—expecting that 2015 would finally see interest rates rise across the board. According to Barclay’s Bank indices, U.S. liquid corporate bonds with a 1-5 year maturity are yielding 2.74 percent on average, almost a third of a percent less than a year ago. 30-year Treasuries are yielding 2.91 percent, and 10-year Treasuries currently yield 2.12 percent.
Considering how difficult and turbulent the markets were, our portfolios held up reasonably well but delivered slightly negative results. The largest portfolio detractors were significantly lower oil prices, a further deceleration in China, and overall Emerging Market weakness. For Emerging Markets, much of their economic production is commodity based. As their currencies dropped in value, the price they received for those commodities fell and that continued the downward spiral. However, the middle class is growing quickly in these countries and should drive huge economic gains over the next several decades. One analysis estimates the middle class of China over the next 10 years will be five times the current size of the U.S. middle class. This economic growth should have corresponding rewards.
In addition to the effect of Emerging Markets weakness, portfolios were affected because a portion—directly or indirectly—was invested in commodities, by far the biggest loser of 2015. Commodity investments are considered a diversifier, and nobody can tell when they’re going to add significantly to a portfolio’s value. However, in the last 12 months, they continued a longstanding losing streak, with the Standard & Poor’s GSCI falling 16.63 percent in the fourth quarter. Some have speculated that the largest contributor, a surprising continuation of the decline in oil prices, may have been accelerated by a Saudi Arabian attempt to flood the oil markets as a failed strategy to put American frackers out of business.
Looking ahead, a big warning sign is China, which is becoming the 800 pound gorilla of the global markets. The Shanghai Composite Index lost -43 percent of its value during a frightening summer selloff, and China’s economic growth has clearly slowed from the pell-mell double-digit growth rates of the past 20 years. Lost in the hand-wringing is the fact that China’s primary index finished the year with a 9 percent gain overall. The selloff simply wiped out most of an enormous bull run in the first three months of the year. More troubling than the losses is the government’s willingness to try to manipulate its equity markets, which means it’s hard to discern the fair value of individual Chinese stocks.
Finally, we’ve seen the Federal Reserve Board’s first tentative effort to let the short-term fixed income markets find their natural level, which has already led to higher mortgage rates. Nobody knows if or when the Fed will raise rates again in the new year or what the impact would be. The fact is we are in an election year and the economy is showing modest growth, suggesting that the central bank’s policymakers will proceed very cautiously.
What’s going to happen in 2016? Of course, nobody knows with any degree of certainty. Many professional investors are approaching the new year with an unusual degree of caution. By most metrics, U.S. stocks are pricier than their historical averages. That doesn’t mean they can’t get more so, but it seems unlikely that people will pay a lot more for a dollar of earnings in the coming year than they will today. Meanwhile, economic growth appears moderate at best, which suggests that, in aggregate, U.S.-based companies likely will only be able to increase their value at moderate rates as well.
Will that happen in the next 12 months? The year has started off as the worst in history, but the markets often punish those who try to outsmart them. While it might not happen in 2016, historically U.S. and international markets have tested and surpassed their previous record highs time and time again.