Market Update for the Quarter Ending December 31, 2015

Presented by Rich Tegge

 A disappointing year for financial markets

U.S. markets disappointed for the first time in years, with weak results for December and 2015 as a whole and despite closing with a very solid fourth quarter. The Dow Jones Industrial Average, S&P 500 Index, and Nasdaq were down in December—1.52 percent, 1.58 percent, and 1.98 percent, respectively. But all were up strongly for the quarter, with the Dow rising 7.70 percent, the S&P 500 gaining 7.04 percent, and the Nasdaq doing best, up a robust 8.38 percent.

For the year, the Dow was up a modest 0.21 percent and the S&P 500 did only slightly better, gaining 1.38 percent. The Nasdaq was up 5.73 percent for the year, though this was well below average annual return levels.

The disappointing results also came despite a slow-but-steady economic recovery. After a weak first quarter, economic growth accelerated, with year-over-year gross domestic product growth running at between 2 percent and 3 percent. Even with this continued growth, however, corporate revenues and earnings actually decreased in the most recent quarters. Moreover, expectations for future corporate growth were adjusted downward. Still, stock prices stayed high until year-end, as did market valuations. Technical factors were generally weak at the end of December, with both the Dow and S&P 500 closing below their major moving averages and the Nasdaq approaching those levels.

Looking forward, conditions may prove more favorable. With the energy industry adjusting to lower oil prices—and the possibility that those prices might increase—one major headwind may abate. Similarly, growth in consumer spending should help domestic results, even as companies adjust to the effects of the strong dollar. If these factors merely flatten out, they will pose less of a headwind to markets than they did in 2015.

International markets underperformed U.S. markets over all time periods in 2015, with December a weak month just as it was in the U.S. The MSCI EAFE Index, which represents developed international markets, was down 1.35 percent for December, leaving a gain of 4.71 percent for the fourth quarter. The MSCI Emerging Markets Index fared worse, down 2.48 percent for December and posting a marginal 0.26-percent gain for the quarter.

For the year as a whole, international developed markets were down 0.81 percent, and emerging markets were down 16.96 percent. Technical factors remained weak, with both indices ending the year well below their 200-day moving averages. Lukewarm economic factors, coupled with political difficulties around the world, suggest that the technical weakness may hang on through 2016. Continued low prices for oil and other commodities hit emerging markets hard, while rising political conflict and economic stagnation, particularly in Europe, weighed on developed markets.

Fixed income also had a relatively weak 2015 in the U.S. The Barclays Capital U.S. Aggregate Bond Index was down 0.32 percent for December and down 0.57 percent for the fourth quarter, which resulted in a gain of only 0.55 percent for the year as a whole. This weak performance was largely driven by volatility in interest rates throughout 2015. Rates on the benchmark 10-year U.S. Treasury bond increased from 2.12 percent to 2.27 percent during the year, with interim declines to a floor of 1.68 percent in January and a peak of 2.50 percent in June. Rates in the last quarter showed a greater increase, from 2.05 percent to 2.31 percent, spurred by the Federal Reserve’s (Fed’s) decision to increase short-term rates in December.

The increase in rates was smaller than it might have been, largely engendered by uncertainty elsewhere in the world and ongoing stimulus from central banks in China, Japan, and Europe. As the Fed slowly moved out of the market, others stayed in or moved to stimulate further.

Economic recovery continues slow but steady

The major economic story for the fourth quarter was the Fed’s decision to raise target interest rates, signaling that, in its judgment, the economy was strong enough to accommodate a move toward normal interest rates. Although concerns remain and the Fed continues to keep short-term rates at very low levels, the question has now moved to how quickly those rates will increase—and that depends on the continued improvement of the economy.

Despite weakness in manufacturing and energy, the service sector—which roughly constitutes seven-eighths of the economy—performed strongly, generating substantial improvement in employment. More than 2.6 million jobs were created in 2015, extending a strong run from 2014. Further, November’s employment report showed 13.7 million jobs created since the 2008 financial crisis versus 8.8 million jobs lost. The report also showed that 2015 will be the third year in a row with an average of more than 200,000 jobs created per month and that the overall unemployment rate has dropped to the precrisis level of 5 percent.

At the end of the year, even the major remaining employment concern—slow wage growth—was showing signs of improvement, accelerating to new highs. Still better, wage income growth was substantially faster than wage growth itself, based on strong job creation and labor demand. And even though consumer spending growth was slower than wage income growth, savings rates were approaching previous high levels, suggesting that spending could accelerate. With consumer spending accounting for more than two-thirds of the economy, the foundation for economic growth looks solid heading into 2016.

Low oil prices support continued growth

Most observers had expected oil prices to rebound sometime in 2015, but they remained low. After declining about 50 percent from their 2014 peak, spot prices stabilized in mid-2015 at $55 to $60 per barrel, only to drop again in the second half of the year to below $40 per barrel. This volatility is clearly seen in Figure 1.

Figure 1. WTI Crude Spot Prices, January 2014–January 2016

q4 market update

Source: Bloomberg

Although we have no direct evidence of increased consumer spending as a result of lower gas prices, the fact that auto sales rose to more than 18 million vehicles in 2015 suggests that their effect has been positive. Lower energy prices also benefit companies, in the form of lower costs, which helps profit margins and potentially stock prices.

Looking ahead, even though the previous decline in oil prices has worked its way into the economy, most of the more recent decline has probably not, suggesting that economic growth may continue to accelerate. Certainly there are downsides to declining energy prices in the forms of lower investment and hiring, but many of these drawbacks have made their marks, so the overall impact of lower oil prices should continue to be positive.

Lower oil prices will also benefit other countries, especially China, Europe, and Japan. These economies continue to stagnate, and lower energy costs will act as a much-needed stimulus, just as in the U.S. Even in countries that will suffer from lower prices, such as Russia, Iran, or Venezuela, the net effect for the U.S. is likely to be positive.

To sum things up: low oil prices won’t last forever, but at this point it seems likely that prices will remain low through most of 2016, which should act as an ongoing stimulus to the U.S. and global economies.

U.S. outlook remains good, but there are risks

With the U.S. economy recovering and indicators looking good for continued growth, we begin 2016 with a positive outlook. At the same time, substantial risks remain, and investors should be cautious.

Viewing the world as a whole, China’s growth continues to decline, and both Europe and Japan remain at risk economically. In the case of Europe, the risks are also political, as the tide of Syrian refuges still stresses the European Union. Perhaps most worrisome is the Middle East, where ISIS is expanding and exacerbating the Sunni/Shia confrontation.

Here in the U.S., even with the strong economic fundamentals, there are signs of a slowdown. Corporate fundamentals may be weakening, though stock market valuations remain high. Expected earnings growth has already been downgraded for 2016, and further downgrades are possible.

All of these risks notwithstanding, we enter 2016 in a much better place than we were one year ago. The U.S. economy is solid, and the trends are good. Risks are omnipresent, but with a solid foundation we are well positioned to overcome challenges. As always, a long-term perspective and diversified portfolio remain the best ways to take advantage of investment opportunities and overcome risks.

 All information according to Bloomberg, unless stated otherwise.

 Disclosure: Certain sections of this commentary contain forward-looking statements that are based on our reasonable expectations, estimates, projections, and assumptions. Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict. Past performance is not indicative of future results. Diversification does not assure a profit or protect against loss in declining markets. All indices are unmanaged and investors cannot invest directly into an index. The Dow Jones Industrial Average is a price-weighted average of 30 actively traded blue-chip stocks. The S&P 500 Index is a broad-based measurement of changes in stock market conditions based on the average performance of 500 widely held common stocks. The Nasdaq Composite Index measures the performance of all issues listed in the Nasdaq Stock Market, except for rights, warrants, units, and convertible debentures. The MSCI EAFE Index is a float-adjusted market capitalization index designed to measure developed market equity performance, excluding the U.S. and Canada. The MSCI Emerging Markets Index is a market capitalization-weighted index composed of companies representative of the market structure of 26 emerging market countries in Europe, Latin America, and the Pacific Basin. It excludes closed markets and those shares in otherwise free markets that are not purchasable by foreigners. The Barclays Capital Aggregate Bond Index is an unmanaged market value-weighted index representing securities that are SEC-registered, taxable, and dollar-denominated. It covers the U.S. investment-grade fixed-rate bond market, with index components for a combination of the Barclays Capital government and corporate securities, mortgage-backed pass-through securities, and asset-backed securities.

Rich Tegge is a financial advisor located at Wealth Strategy Group, 300 S. Front Street Ste C Marquette, MI  49855. He offers securities and advisory services as an Investment Adviser Representative of Commonwealth Financial Network®, Member FINRA/SIPC, a Registered Investment Adviser. He can be reached at 906-228-3696.

Authored by Brad McMillan, senior vice president, chief investment officer, at Commonwealth Financial Network.

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