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www.blueoceanglobalwealth.com Insight. Clarity. Purpose.
2015 Financial Market Update and Look Ahead
— December 31, 2015 Auld Lang Syne and Key Themes Heading into 2016 In some respects, 2015 was a year that unfolded as expected – predictability and surprises. The economy continued to plod ahead, the unemployment rate fell, and the Federal Reserve finally lifted the fed funds rate.
Index Q4 Return %* 2015 YTD Return % DJIA1 +7.00 -‐2.23 NASDAQ Composite2 +8.38 +5.73 S&P 500 Index3 +6.45 -‐0.73 FTSE Developed ex North America Index4
+4.59
-‐2.09
Bond Yields Yield* -‐ % a/o Dec 31, 2015 Yield -‐ % a/o Dec 31, 2014
3-‐month T-‐bill 0.16 +0.16 0.04 2-‐year Treasury 1.06 +0.42 0.67 10-‐year Treasury 2.27 +0.21 2.17 30-‐year Treasury 3.01 +0.14 2.75 Commodities Dec 31 Price, Quarterly Change* Year end 2014 Oil per barrel5 $37.07 -‐10.02 $53.27 Gold per ounce6 $1,062.25 -‐51.75 $1,206.50
Sources: U.S. Treasury, MarketWatch, St. Louis Federal Reserve, CNBC *Quarterly: September 30, 2015 – December 31, 2015
Charles Sherry Director, Institutional Education Group Blue Ocean Global Wealth 51 Monroe St., Plaza West 06 Rockville, MD 20850 Tel: 720.308.4560 [email protected]
www.blueoceanglobalwealth.com Insight. Clarity. Purpose.
But we also witnessed the tale of two economies: service industries expanded at a modest pace, but falling exports (U.S. Census) and huge cutbacks in the energy sector took a toll on manufacturers. Meanwhile, the relative outperformance of the U.S. economy versus its global partners kept upward pressure on the dollar. On the equity front, the S&P 500 Index lost ground for the first time since 2008, and stocks experienced their first 10%+ correction in four years, as measured by the S&P 500 Index (St. Louis Federal Reserve). Problems with China’s economy were primarily blamed for the August/September selloff, but market internals had already turned south, and anxieties attached to the global economy provided the perfect excuse for short-‐term traders to hit the sell button – see Figure 1. While the general market was little changed, consumer issues, health care, and technology finished in the green (Bloomberg). Not surprisingly, commodity and oil-‐related shares were hit hard against the backdrop of sinking prices for all-‐things raw materials. Despite expectations for a hike in the fed funds rate and the follow through in December by the Fed, Treasury yields remain at historically low levels – see Figure 1.
It may have to do with expectations that inflation and growth in the U.S. will remain low. But very low government bond yields in Europe (Bloomberg) may also be playing a role, too. Today, cash can quickly move across borders, and rock bottom yields in Europe attract capital from abroad, which is seeking relatively higher returns.
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12/31/2014 3/31/2015 6/30/2015 9/30/2015 12/31/2015DATA SOURCE: ST. LOUIS FEDERAL RESERVE, U.S. TREASURY LAST DATE: 12.31.15
Stock and Bond Performance
S&P 500 Index-‐percent change 10-‐year Treasury yield
Treasury Yield S&P 500Fig. 1
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A look ahead Peering into the future is always fraught with peril. No has a crystal ball, period. The bull market is set to enter its eighth year in March, but that doesn’t necessarily mean 2016 will mark its demise. Many may site the upcoming election. Stocks typically outperform during an election year, right? Well, 50 years of data compiled by Deutsche Bank suggest an election doesn’t provide any oomph to stocks. In other words much will depend on the economy and corporate profits. But issues that held sway in 2015 could continue to influence sentiment including earnings, the global economy, the dollar, and low commodity prices. 1-‐Earnings – it’s the lifeblood of stocks and the biggest driver of the medium and long-‐term direction of equities. Using monthly data going back to 1923 (Robert Shiller, PhD, Yale.edu), there is a 96% correlation between S&P 500 earnings and the S&P 500 Index. That’s an extremely close correlation where 100% would mean the two variables move in lockstep. Thanks in large part to the steep drop in oil prices, profits at energy-‐related firms took a huge tumble last year (Thomson Reuters). In turn, that created a big headwinds to overall corporate profits – see Figure 2. In fact, Q3 2015 earnings, which were down a scant 0.8% from a year ago, would have been about seven percentage points higher if energy had been excluded, according to FactSet Research.
*Projected earnings are subject to change
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2015 Q1 Q2 Q3 Q4 2016 Q1 Q2 Q3
Data Source: Thomson Reuters Last Date: 12.31.2015
S&P 500 Earnings and Energy Earnings -‐ % change from one-‐year ago
S&P 500 Earnings
Energy Sector
Percent
Projected* earnings
Fig. 2
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In addition, the stronger dollar has created additional headwinds for multinationals, which much translate sales abroad back into the stronger greenback. But note that analysts are expecting earnings to turn positive in Q1 2016 and accelerate as the year progresses. Modest growth in profits would likely create a tailwind for stocks, but much of the pick-‐up is predicated on a continuation of the economic expansion, a bottom in oil prices, and greater stability in the dollar. Most analysts don’t anticipate a recession in the near term, but the direction of the dollar and oil is a bit fuzzier. Still, the forecast for rising profits is cautiously encouraging. 2-‐Too much oil, commodities and the dollar – Low commodity prices have benefitted nearly everyone outside of the energy industry. But woes in the commodity sector have hurt emerging market economies, and companies in the mining industry. Much of the drop in commodity prices can be pinned on China, which is undergoing a transformation from an economy that is reliant on its industrial sector to one that is more balanced between consumer/service needs and goods producers. Consequently, China’s voracious appetite for raw materials has slowed, sending prices down to the lowest level in over a decade – see Figure 3. But another factor that influences commodities is the dollar. The reason – most commodities that are sold around the globe are priced in dollars, which means a rising U.S. currency puts downward pressure on prices. It’s a plus for consumers but it hurts producers.
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Note: the Thomson Reuters/CoreCommodites CRB Index is a comprised of a broad basket of commodities, which cannot be invested into
directly. Past performance is no guarantee of future performance.
The Dollar Index – Major Currencies is an index that measures the dollar’s performance against the currencies of major U.S. trading partners.
The Dollar Index cannot be invested into directly. Past performance is no guarantee of future performance.
Falling prices have pressured global sentiment, which in turn has hindered the broader stock market. For many at home, the collapse in the price of oil has been a bigger story. Like most commodities, oil is also priced in dollars. Note the decline below $100 per barrel coincides with the recent surge in the greenback – see Figure 4.
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7/31/1991 7/31/1996 7/31/2001 7/31/2006 7/31/2011Data Source: St. Louis Federal Reserve, FreeStockCharts Last date: 12.24.15
Commodities and the Dollar
Thomson Reuters/CoreCommodites CRB Index
Dollar Index -‐ Major Currencies
Descending -‐ stronger dollarAscending -‐ higher commodity pricesFig. 3
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1/3/2001 1/3/2004 1/3/2007 1/3/2010 1/3/2013Data Source: St. Louis Federal Reserve Last date: 12.24.15
Oil and the DollarWest Texas Intermediate Crude Oil Dollar Index: Major Currencies$/barrel
Fig. 4
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While many of us are being treated to the lowest prices at the pump in years, weakness in energy has forced sizable layoffs among oil producers and big cutbacks in capital spending (U.S. Bureau of Labor Statistics). In addition to the strength in the dollar, I would be remiss if I didn’t cite soaring production of shale oil, which has helped create a global glut of crude amid a drop in U.S. imports (U.S. Energy Information Administration). While production has started to decline in response to lower prices (U.S. EIA), output from the shale fields has proved to be far more resilient than many had expected. Looking ahead, what happens to China and the dollar will likely have an influence on the commodity sector this year. But what occurs in the U.S. oil fields will also play a role. Greater stability would lessen the uncertainty for investors. However, trends in commodities, including oil, tend to move in long-‐term cycles. 3-‐Problems have emerged in high-‐yield debt, commonly called junk bonds. Thanks in large part to woes in the mining and energy sectors, yields on junk bonds have risen as investors have bailed out of low-‐grade energy and mining debt (bond prices and yields move in opposite directions). Moreover, the riskiest bonds, or those with the lowest credit quality, have seen the largest jump in bond yields – see Figure 5. In less than a year, yields with a ‘CCC’ rating have more than doubled, and the difference in yield between higher quality junk debt (BB) and lower quality junk (CCC) has widened significantly.
Last Date: 12.30.15 The BofA Merrill Lynch US Effective Yield BB and CCC or below provide the yield for bonds in those respective categories. Neither can be
invested into directly. Past performance is no guarantee of future performance.
Note: Standard & Poor’s rates bonds from a scale of AAA (strongest credit quality) to D (lowest credit quality). Bonds rated below ‘BBB-‐‘ or not
considered to be investment grade, and or typically referred to as ‘high-‐yield’ or ‘junk’ debt.
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Percent
Data SourceSt. Louis Federal Reserve, NBER Shaded area marks recession
Yields on Junk Debt
BofA Merrill Lynch US Effective Yield CCC or below
BofA Merrill Lynch US Effective Yield BB
Spread between CCC and BB
Fig. 5
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Rattle the bond market and you can rattle the stock market. Yet, measures of credit conditions used by the Federal Reserve indicate financial stresses in the economy remain muted entering the New Year (St. Louis Federal Reserve). If oil and the commodity sector begin to bottom and the economy continues to expand at a modest pace, historical analysis suggests that much of the damage in junk bonds is probably behind us. However, a lack of liquidity is the sector, the outside potential for a broader economic slowdown, and continued problems in mining and energy may generate additional uncertainty. While the jury it still out, a Federal Reserve that encouraged very low interest rates, which in turn, also encouraged a reach for yield by investors, may have created too much enthusiasm for high-‐yield debt over the last couple of years. At her December press conference, Fed Chief Janet Yellen sidestepped a question that aimed to pin part of the blame for high-‐yields selloff on Fed policy (Fed press conference transcript).
Additional issues The most likely path in 2016 probably bears plenty of resemblance to 2015 – a modest but less than impressive expansion that lends support corporate profits. But let me remind you that peering into the future is an educated guess at best. What happens with Europe, Greece, China, the Federal Reserve, and geopolitical instability can cause temporary shifts in sentiment. Then there are the unanticipated events that could hinder or fuel gains this year. Ultimately, the domestic economy has the biggest impact on markets. Even events tied to terrorism rarely have a long-‐term influence on stocks. Following the tragedy of 9-‐11, the S&P 500 Index fell nearly 12% in the first 5 trading days, but had completely erased losses by October 11, 2001 (St. Louis Federal Reserve). Historically, the long-‐term investor that adheres to a professionally crafted investment plan is more likely to achieve his/her financial objectives. If your personal situation has changed, let’s talk. 1 The Dow Jones Industrials Average is an unmanaged index of 30 major companies which cannot be invested into directly. Past performance does not guarantee future results.
2 The NASDAQ Composite is an unmanaged index of companies which cannot be invested into directly. Past performance does not guarantee future results.
3 The S&P 500 Index is an unmanaged index of 500 larger companies which cannot be invested into directly. Past performance does not guarantee future results.
4 The FTSE Developed ex North America Index is an unmanaged index of large and mid-‐cap stocks providing coverage of developed markets, excluding the US and Canada. It cannot be invested into directly. Past performance does not guarantee future
results.
5 New York Mercantile Exchange front-‐month contract; Prices can and do vary; past performance does not guarantee future results.
6 London Bullion Market Association; gold fixing pricing at 3 p.m. London time; Prices can and do vary; past performance does not guarantee future results.
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