Market Review - Fourth Quarter 2015
The major stock market indices had positive returns in the fourth quarter of 2015. However, with the exception of the S&P 500 Index, the other major indices suffered losses for all of 2015. S&P 500 managed a small gain of 1.4% for the full year.
In 2015 stock market performance was negatively impacted by disappointing corporate earnings, the Fed Reserve adopting a less stimulative policy stance, concern related to a slowing Chinese economy, and continued economic weakness in Europe. For the fourth quarter of 2015, earnings for companies comprising the S&P 500 are forecasted to decline for the fourth consecutive quarter. While many companies in the S&P 500 are performing well operationally, earnings have been hurt by poor results in the energy sector and the impact of a higher dollar, which has resulted foreign earnings being translated into fewer dollars. In December, the Federal Reserve increased it benchmark by 0.25% to a range of 0.25% to 0.50% in an effort to gradually move rates to a more normal level. While this move was widely anticipated, it raised concern for some market participants.
The table below shows the performance of major equity indices for various time periods.
Equity Performance for Periods Ending on December 31, 2015
|Total Return Index||Market Sector||Quarter||1-year||3-year||5-year||10-year|
|S&P 500||Large U.S. Companies||7.0%||1.4%||15.1%||12.6%||7.3%|
|Russell 2000||Small U.S. Companies||3.6%||-4.4%||11.7%||9.2%||6.8%|
|MSCI EAFE||Developed Int’l Markets||4.4%||-3.3%||2.3%||0.7%||0.2%|
|MSCI EM||Emerging Int’l Markets||0.3%||-17.0%||-9.0%||-7.2%||1.2%|
It is particularly interesting to note that the S&P 500 is the best performing index for all period shown. This is a highly unusual occurrence since market sectors typically go in and out-of-favor with investors. Diversification across all major equity sectors typical produces more stable short-term results (lower risk) without detracting from long-term performance. This is because the performance of each sector usually varies significantly in the short-term, but will be somewhat similar over longer time frames. This why diversification has sometimes been called the only free lunch in investing. While some might question the value of diversification considering recent performance, we feel the results shown represent an anomaly and that longer-term performance of these sectors will once again converge.
It is also worth noting that the 10-year performance for each index is significantly below its long-term average. For example, the S&P 500 returns of 7.3% are below the 50-year average of 9.6%. This might partially be explained by a lower inflation rate in recent years. For the 50-year period ending in 2015, the annual inflation rate averaged 4.1%. This meant that the real annualized returns for the S&P 500 over the past 50 years were 5.5% (9.6% less 4.1%). Over the past 10 years, inflation has averaged just 1.8%. The real annualized returns for the S&P 500 over that past 10 years were also 5.5% (7.3% less 1.8%). We believe that the relationship between inflation and stock returns is likely to persist. If inflation remains low for the next several years, which we believe is likely, stock returns are likely to trend below the long-term historic average.
While lower inflation might help to explain lower returns of the U.S. market over the past 10 years, the reasons for the poor recent performance of international markets are more complex. The developed international markets seem to be suffering from stagnant population growth and lingering problems related to the Great Recession. The demographics of Europe and Japan reflect low or negative population growth and an aging population. In addition, some governments have promised their citizens social programs without the necessary tax base to fund them. Developed international economies are likely to struggle to achieve growth, even with the aggressive stimulus programs currently in place.
Growth of emerging market economies, while still expanding at a much faster pace than the developed world, has recently fallen short of expectations, causing weakness in stock performance for this sector. The International Monetary Fund is forecasting 4.5% growth for emerging market economies in 2016, compared to just 2.2% for developed economies. The two fastest growing major economies in 2016 are expected to be India and China, with 7.5% and 6.3% growth, respectively. However, emerging market performance has negatively reflected a slowing growth rate in China (down from 6.9% in 2015) and recessions in Brazil and Russia.
Although 2015 was a difficult year for diversified equity investors, we are modestly optimistic that stock market returns will improve in 2016. The U.S. economy is forecasted to grow between 2% and 3% in 2016. While the Fed is likely to continue to raise rates gradually as part of its normalization policy, we believe interest rates will remain in a range that will support economic growth. Stimulative policies in most international economies should help to improve overall global growth. Earnings for S&P 500 companies are forecasted to grow by 8% next year. While lower energy prices had a negative impact on stocks in 2015, the reverse could be true in 2016. The short-term impact of lower oil prices was lower earnings for energy companies, which hurt stock market performance. The longer-term effect is a savings for energy consumers. U.S., Europe, China, and India are net importers of oil and should experience an economic benefit from lower energy prices. Finally, although there is concern over global economic growth, we believe that most corporations have adjusted their business models so that they are able to deliver returns to shareholders even in a low growth environment.
Interest rates moved slight higher in the fourth quarter, but remained low compared to historical averages. The yield on the 10-year Treasury bond ended the year at 2.27%, up from 2.06% the end of September, and 2.17% at the beginning of the year. The BarCap U.S. Aggregate Bond Index, the broadest benchmark of the U.S. bond market, produced a loss of -0.6% for the fourth quarter and small gain of 0.6% for all of 2015. The current low interest rate environment, coupled with the likelihood that rates will continue to increase, makes us regard fixed income investments relatively unattractive.
Although returns for all major asset classes were disappointing in 2015, we remain positive about the long term. While the current economic expansion is now more than five years old, there are no apparent signs of either excesses or a recession. We continue to believe that good long-term performance can be obtained by maintaining an asset mix that is appropriate for an investor’s objectives and risk tolerance, utilizing diversification to control risk, and owning investments that are reasonably valued.
John D. Frankola, CFA
The author is the president of Vista Investment Management, LLC, a Registered Investment Advisory firm. Under no circumstances does this article represent a recommendation to buy or sell stocks. This article is intended to provide information and analysis regarding investments and is not a solicitation of any kind. References to historical market data are intended for informational purposes; past performance cannot be considered a guarantee of future performance. Neither the author nor Vista Investment Management, LLC has undertaken any responsibility to update any portion of this article in response to events which may transpire subsequent to its original publication date.