2015 Review: Economy & Markets

rollercosterThe US economy and broad market showed modest gains during the year, although investor discipline was tested by news of a global economic slowdown, rising market volatility in China and emerging markets, falling oil and commodities prices, and higher US interest rates.

The S&P 500 Index logged a 1.38% total return. The returns across US indices were mixed, but overall the broad US market, as measured by the Russell 3000, gained 0.48%—its lowest return since the 2008 market downturn. The Nasdaq Composite Index returned 6.96%. Performance among non-US markets was mostly negative: The MSCI World ex USA Index logged a ‒3.04% total return and the MSCI Emerging Markets Index a ‒14.92% return (net dividends, in USD). The US dollar’s strong performance against major currencies resulted in lower returns for US investors in various markets. For example, the MSCI All Country World Index returned 1.27% in local currency but ‒2.36% in USD (net dividends).

For most of the year, investors considered the potential impact of higher US interest rates triggered by a US Federal Reserve Bank (Fed) rate increase. The Fed’s announcement finally came in December and by year-end, the yield on the benchmark 10-year Treasury note stood at 2.27%, up from 2.17% in 2014. The Barclays US Government Bond Index returned 0.86% and Barclays US Intermediate Corporate Index returned 1.08%. Global government bonds had slightly positive returns with the Citigroup World Government Bond 1–5 Year Index (USD hedged) returning 1.00%. Global corporate bonds also had positive returns, with the Barclays Global Aggregate Corporate Bond Index 1–5 Years (hedged to USD) returning 1.21%.

2015 1st pic

The chart above highlights some of the year’s prominent headlines in context of broad US market performance, measured by the Russell 3000 Index. These headlines are not offered to explain market returns. Instead, they serve as a reminder that investors should view daily events from a long-term perspective and avoid making investment decisions based solely on the news.

The chart below offers a snapshot of non-US stock market performance (developed and emerging markets), measured by the MSCI All Country World ex USA Index. The headlines should not be viewed as determinants of the market’s direction but as examples of events that may have tested investor discipline during the year.

2015 2ond pic

Global Backdrop

US Economy

The US economy grew modestly during 2015. Gross domestic product (GDP) increased only 0.6% in Q1 before improving to 3.9% in Q2 (year over year). Growth slowed to 2.0% in Q3, matching the average annualized growth for the past six years. Q4 GDP growth was forecasted to decline to 1.0% and GDP growth for all of 2015 to average 2.5%.

Positive economic signs in 2015 included lower unemployment, which fell from 5.7% in January to 5.0% in the last three months of the year—the lowest rate since 2008. Overall, the economy added 2.7 million jobs, capping the second-best annual gain since 1999. December wages were up 2.5% (year over year), which marked one of the best gains of the current expansion, although still below the 6.33% annual average. Inflation (personal consumption expenditures index) remained low. November’s 0.5% rate (year over year) marked the 43rd straight month of annualized inflation below the Fed’s 2% target rate. US housing activity remained solid with price growth, as measured by the S&P/Case-Shiller Home Price Index, rising 5.2% (year over year) through October. New home sales increased 14.5% through November. Consumer confidence also improved, with the University of Michigan’s Index of Consumer Sentiment averaging 92.9 in 2015—the highest since 2004. Consumer spending, which accounts for more than two-thirds of US economic activity, grew 3.0% in Q3.

Negative economic indicators included declining US factory activity. In December, the Institute for Supply Management’s (ISM) index fell to 48.2 from 48.6 in November, which was the weakest reading since the final month of the recession in June 2009. (Readings below 50 indicate contraction.) Corporate profits declined in Q1 and Q3 by 5.8% and 1.6%, respectively, and profits at S&P 500 companies were projected to fall by 3.6% in Q4.

Global Economy 2015 3rd pic colum

In 2015, economic growth was the weakest since the financial crisis. In December, the Organization for Economic Cooperation and Development (OECD) revised its 2015 world growth estimate downward to 2.9%—well below the historical average of 3.6% per year.

Eurozone GDP growth increased 0.5% in Q1, which was the strongest quarterly rate since its regional recovery began in early 2013. But the pace slowed to 0.4% in Q2 and to 0.3% in Q3. The slowdown came in spite of improved consumer spending sparked by lower energy prices and the European Central Bank’s (ECB) quantitative easing efforts. A decline in the euro’s value boosted exports and contributed to an improved current account surplus (3.7% of GDP) in 2015. Japan’s economy showed signs of improvement early in 2015 by posting a 3.9% GDP growth rate in Q1. Growth in Q2 reversed with a –0.7% rate before rebounding to 1% in Q3.

China, the world’s second largest economy, showed signs of a slowdown during 2015, with Q1 and Q2 growth reported at 7% and Q3 growth falling to 6.9%, which was less than half the growth rate in 2010. The Chinese government later revised its growth target to 6.5%, reflecting the weakest growth in 25 years.

After several years of robust growth, emerging market nations began to feel the effects of China’s slowdown, persistently weak global commodity prices, and the prospect of higher US interest rates. In Q4, the International Monetary Fund (IMF) cut its 2015 growth estimate for emerging markets to 4%, which marked the fifth consecutive year of declining growth.

Oil Market Decline

The world oil market continued its dramatic slide. After falling more than 50% in 2014, oil declined another 30% to end 2015 at $37.04 a barrel for West Texas intermediate crude, marking the largest two-year price drop on record. Factors affecting the price decline include: (1) excess supply spurred in part by higher production in North America, Middle East, and Russia, (2) slack demand due to slowing global growth, especially in the emerging markets, and (3) OPEC’s waning ability to influence market prices by adjusting its production. While cheap oil was a boon to consumers in developed economies, the steep price decline brought uncertainty to financial markets and industry sectors as firms curtailed spending and canceled projects, and oil-exporting countries collected lower tax revenues and struggled with the effects of a weaker currency.

Diverging Paths for Central Banks 

The divergence in actions by the major central banks in 2015 marked the first time since the euro’s launch that the Fed, ECB, and Bank of England have been compelled to strike different monetary paths as a result of diverging economies. In the late 1990s, the booming global economy led the central banks to apply rate hikes, while the 2001–2003 market decline brought similarly timed rate cuts.

In September, the Fed postponed raising interest rates, citing concerns with the economy, inflation, and worldwide market volatility. The central bank raised its benchmark rate by a quarter point in December—its first rate hike since 2006—and stated that it would continue on a gradual course of monetary tightening as long as inflation and economic growth allowed. The impact on the US financial markets was negligible, as rates had already begun to increase in anticipation of the move. Even as the US central bank began monetary tightening, most banking authorities across the globe were taking measures to ease their country’s monetary policy in response to signs of an economic slowdown. The ECB implemented a major stimulus program throughout the year, and in December announced new quantitative easing measures along with Japan. More than 40 central banks across the globe eased monetary policy in 2015.

China’s Rising Influence

Markets closely followed the news about China’s declining economic growth and the severe downturn over the summer, when the Chinese equity market declined more than 40% from its peak. Attempts by the Chinese authorities to support stock prices and the Bank of China’s surprise devaluation of the yuan raised questions about China’s impact on the economies of trading partners. The events also pointed to the stresses the government faces in implementing additional free-market reforms and transitioning its economic model from heavy industry and exports to one based more on consumer spending.

Market Summary2015 Investment Overview

In the US equity markets, most major indices logged negative performance, despite a strong rebound during Q4. For the year, the S&P 500 Index returned 1.38%; the Russell 3000 Index 0.48%; and the Russell 2000 Index ‒4.41%.

US market volatility, measured by the Chicago Board Options Exchange Market Volatility Index (VIX), declined steadily for the first half of 2015, but jumped to its highest level in six years in late August, following the US market decline. During Q4, the index dropped then rose again to close slightly higher for the year.

2015 4th pic columNon-US developed stock markets experienced mixed performance across almost all major indices (returns in USD, net dividends). The MSCI World ex USA Index, a benchmark for large cap stocks in developed markets outside the US, returned ‒3.04%. Small cap and value stock returns were mixed: The MSCI World ex USA Small Cap Index returned 5.46% and MSCI World ex USA Value Index returned ‒7.68%. The MSCI World ex USA Growth Index was positive at 1.65%. Emerging markets were among the worst global performers: The MSCI Emerging Markets Index returned -14.92%; the small cap subindex returned ‒6.85%; the value subindex returned ‒18.57%.

Among the equity markets tracked by MSCI, nearly half of the countries in the non-US developed markets index had negative total returns (in USD) and the range of returns was broad. The top three return countries were Denmark (23.43%), Ireland (16.49%), and Belgium (12.10%). Countries with the lowest returns were Canada (‒24.16%), Singapore (‒17.71%), and Spain (‒15.64%).

In emerging markets, 21 of 23 countries tracked by MSCI logged negative total returns (in USD) and the dispersion of returns was broader than in the developed countries. Hungary (36.31%), Russia (4.21%), and India (‒6.12%) were the top-performing countries in the index. The lowest returns in the index came from Greece (‒61.33%), Colombia (‒41.80%), and Brazil (‒41.37%).

Returns of major fixed income indices were slightly positive. One-year US Treasury notes returned 0.15%, Barclays US Government US Bond Index 0.86%, Citigroup World Government Bond Index (1‒5 years, USD hedged) 1.00%, and Barclays US TIPS index returned ‒1.44%. The Barclays Global Aggregate Corporate Bond Index 1–5 Years (hedged to USD) returned 1.21%.

US and global real estate securities had mixed performance: The Dow Jones US Select REIT Index returned 4.48%, and the S&P Global ex US REIT Index returned ‒3.54%. Commodities were negative for the fifth year in a row, with the Bloomberg Commodity Total Return Index returning ‒24.66%. Among the composite indices, petroleum returned ‒39.42% and industrial metals ‒26.88%. Among the single commodity indices, Brent crude (‒45.57%) and West Texas intermediate crude (‒44.35%) were the worst performers. Natural gas returned -39.95%. Gold was down for the third year in a row at ‒10.88%; silver prices returned ‒12.72%. Cotton was the only commodity in the index to post a positive return (2.97%).

The US dollar rose against most major currencies, including the euro, pound, and yen. The dollar’s strength had a negative impact on returns for US investors with holdings in unhedged non-US assets. For example, in 2015, the dollar’s rise relative to the euro hurt the returns of US investors in European markets. The MSCI Europe Index (net dividends) returned 8.22% in euro but ‒2.84% in US dollars. This was the case in other regions where the dollar outperformed local currencies. Examples: The MSCI United Kingdom Index (net dividends) returned ‒2.21% in pounds and ‒7.56% in USD. The MSCI Australia Index returned 1.29% in Australian dollars but ‒9.95% in USD.

Currency Impact

Performance of Size and Value Premiums

Based on the respective total returns of the Russell indices1within the size dimension, US small cap stocks underperformed US large cap stocks by ‒5.33% (‒4.41% vs. 0.92%). Within the relative price dimension, US value underperformed US growth by ‒9.22% (‒4.13% vs. 5.09%). Among US small cap stocks, small value underperformed small growth by ‒6.09% (‒7.47% vs. ‒1.38%); among US large cap stocks, large value underperformed large growth by ‒9.49% (‒3.83% vs. 5.67%).

As in most years, diverging performance of various subindices in 2015 underscores the fact that the premium within a particular dimension (e.g., size or value) does not always move in the same direction across the global markets. For example, although the size premium was negative in the US, it was positive in both the developed non-US and emerging markets for the year. The MSCI World ex USA Small Cap Index outperformed the MSCI World ex USA Index by 8.50% (all returns in USD, net dividends). The MSCI Emerging Markets Small Cap Index outperformed the MSCI Emerging Markets Index by 8.07%. Value premiums outside the US were generally negative. The MSCI World ex USA Value Index underperformed its growth counterpart by ‒9.33%; the MSCI Emerging Markets Value Index underperformed the MSCI Emerging Markets Growth Index by -7.24%.

Annual underperformance of the size and value premiums is not unusual from a historical standpoint. Although small cap and value stocks have offered higher expected long-term returns relative to their large cap and growth counterparts, these return premiums do not appear each year.1 For example, since 1979, US small caps have outperformed large caps in 19 of the 37 calendar years—or 51% of the time. Results are similar for the relative price dimension. Since 1979, US value has outperformed growth in 20 of 37 calendar years—or 54% of the time. Small cap value has outperformed small cap growth in 57% of the calendar years.

History also has produced multiyear periods in which US small cap and value stocks did not outperform large caps and growth. The most recent example is three-year underperformance of small cap value vs. small cap growth (2013‒2015). Small value has also underperformed in three straight years (2009‒2011 and 1989‒1991). Other multiyear examples include small caps underperforming large caps (1984‒1987 and 1994‒1998) and value underperforming growth (1989‒1991 and 2009‒2011). Yet, despite even extended negative-premium periods, small cap and value stocks have outperformed their counterparts over time, and when the premiums reversed, they often did so strongly and for multiple years.

  1. 1. US small cap is represented by the Russell 2000 Index; US large cap is the Russell 1000 Index; US value (marketwide) is the Russell 3000 Value Index; and US growth (marketwide) is the Russell 3000 Growth Index. US large value is the Russell 1000 Value Index; US large growth is the Russell 1000 Growth Index. Russell data © Russell Investment Group 1995–2016, all rights reserved.*All Charts by Dimensional Funds

Registered Representative, Securities offered through Cambridge Investment Research, Inc., a Broker/Dealer, Member FINRA/SIPC. Investment Advisor Representative, Cambridge Investment Research Advisors, Inc., a Registered Investment Advisor. Lion’s Share U.S. Financial Services and Dimensional Funds and  Cambridge are not affiliated. Indices mentioned cannot be directly invested in. Past performance is no guarantee.  When you access other linked websites, you assume total responsibility and risk of the websites you are linking to caveat emptor. All expressions of opinion are subject to change without notice in reaction to shifting market conditions. All materials presented are compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. Article are provided for informational purposes, and it is not to be construed as an offer, solicitation, recommendation or endorsement of any particular security, products, or services in Alabama, Florida, Georgia, and Tennessee. No offers may be made or accepted from any resident outside the specific state(s) referenced.

 

2016: Ten Predictions to Count On

perdictionThe New Year is a customary time to speculate. In a digital age, when past forecasts are available online, market and media professionals find it harder to hide their blushes when their financial predictions go awry. But there are ways around that.

The ignominy that goes with making bold forecasts was highlighted in a recent newspaper article, which listed many bad calls US economists had made about 2015. These included getting the timing of the Federal Reserve’s interest rate increase wrong, incorrectly calling for a rise in long-term bond yields, and assuming an end to the commodity rout.1

For the broad US equity market, 22 strategists polled by the Wall Street Journal2 estimated an average increase for the S&P 500 of 8.2% for 2015. The most optimistic individual forecast was for a rise of 14%. The least optimistic was 2%. No one picked a fall. As it turned out, the benchmark ended marginally lower for the year.

In the UK, a poll of 49 fund managers, traders, and strategists published in early January 2015 forecast that the FTSE 100 index would be at 6,800 by midyear and 7,000 points by year-end. As it turned out, the FTSE surpassed that year-end target by late April to hit a record high of 7,103 before retracing to 6,242 by year-end.3

Australian economists were little better. The consensus view, according to a January 2015 Fairfax Media poll, was that local official interest rates would stay on hold all year. The Reserve Bank of Australia proved that wrong a month later, before cutting rates again in May.

It shouldn’t be a surprise that if economists can’t get the broad variables right, it must be tough for stock analysts to pick winners. Even a stock like Apple, which for so many years surprised on the upside, disappointed some forecasters last year with a 4.6% decline.4

In Australia, the “Top Picks for 2015” published by one media outlet a year ago included such names as Woodside Petroleum, BHP Billiton, Origin Energy, and Slater & Gordon, all of which suffered double-digit losses in the past year.5

It should be evident by now that setting your investment course based on someone’s stock picks or expectations for interest rates, the economy, or currencies is not a viable way of building wealth in the long term. Markets have a way of confounding your expectations. So a better option is to stay broadly diversified and, with the help of an advisor, set an asset allocation that matches your own risk appetite, goals, and circumstances.

Of course, this approach doesn’t stop you or anyone else from having or expressing an opinion about the future. We are all free to speculate about what might happen in the economy and markets. The danger comes when you base your investment strategy on such opinions. In the meantime, if you insist on following forecasts, here is a list of 10 predictions you can count on coming true in 2016:

  1. Markets will go up some of the time and down some of the time.
  2. There will be unexpected news. Some of this will move prices.
  3. Acres of newsprint will be devoted to the likely path of interest rates.
  4. Acres more will speculate on China’s growth outlook.
  5. TV pundits will frequently and loudly debate short-term market direction.
  6. Some economies will strengthen. Others will weaken. These change year to year.
  7. Some companies will prosper. Others will falter. These change year to year.
  8. Parts of your portfolio will do better than other parts. We don’t know which.
  9. A new book will say the rules no longer work and everything has changed.
  10. Another new book will say nothing has really changed and the old rules still apply.

You can see from that list that if forecasts are so hard to get right, you are better off keeping them as generic as possible. Like a weather forecaster predicting wind, hail, heat, and cold over a single day, your audience should prepare themselves for all climates.

The future is always uncertain. There are always unexpected events. Some will turn out worse than you expect; others will turn out better. The only sustainable approach to that uncertainty is to focus on what you can control.

In the meantime, let me wish a happy new year to you all.

OUTSIDE THE FLAGS
By Jim Parker
Vice President
DFA Australia Limited

Registered Representative, Securities offered through Cambridge Investment Research, Inc., a Broker/Dealer, Member FINRA/SIPC. Investment Advisor Representative, Cambridge Investment Research Advisors, Inc., a Registered Investment Advisor. Lion’s Share U.S. Financial Services and Dimensional Funds and  Cambridge are not affiliated. Indices mentioned cannot be directly invested in. Past performance is no guarantee.  When you access other linked websites, you assume total responsibility and risk of the websites you are linking to caveat emptor. All expressions of opinion are subject to change without notice in reaction to shifting market conditions. All materials presented are compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. Article are provided for informational purposes, and it is not to be construed as an offer, solicitation, recommendation or endorsement of any particular security, products, or services in Alabama,


1. Malcolm Maiden, “The Year Market Economists Failed to See Coming,” SMH, December 30, 2015.
2. “Strategists Expect Stocks to Keep Climbing in 2015,” Wall Street Journal, January 2, 2015.
3. “Five Fund Strategies to Ride Rising Markets,” The Times, January 3, 2015.
4. “Seven Stocks to Buy for 2015,” CNN Money, December 31, 2014.
5. “Top Stock Picks for 2015,” Motley Fool.