2016 Outlook: The Wall of Worry

January 4, 2016 5:21 pm
Betsey

Betsey A. Purinton, CFP®

Managing Partner & CIO

Going into 2016 the Wall of Worry is high. Then again, stocks traditionally climb that wall of worry.

Even in 2015, when there seemed to be a mountain of fears, stocks were resilient. The Nasdaq ended up; the S&P was pushed very modestly into positive territory and the Dow was essentially flat when dividends were factored in. Perhaps the traditional climb was simply crawling out of the negative territory that was created last August and September.

Perusing our sources of research, I have been struck by how particularly gloomy the worried camp is, while the positive camp is genuinely constructive. Take our primary independent sources of analysis: BCA Research and Ned Davis Research. The former concludes for 2016, “It would be a struggle to give you a cheery story about the macro outlook….For the moment caution is the operative word.” While the latter’s global equities prediction is: “2016 will bring much better returns than did 2015, most likely gains in double digits.”

BCA concentrates on economic theory – analyzing the global economy and focusing on the constraints on growth, which limit market opportunities. Ned Davis’ research, which is based on trend analysis, utilizes proprietary charts to decipher patterns that can help to predict investor behavior and investment performance. Both have been bulls and bears in the past, which means that they try to divorce their research and conclusions from sentiment and bias. Clearly approach matters, but what is surprising is that the conclusions are so different.

One way to explain the dichotomy is from the perspective of timing. For the pessimists 2015’s fears appear to be more entrenched than usual, with negative factors expected to linger well into 2016 and beyond. The optimists tend to see the potential for change and feel the sentiment of gloom can cloud foresight.

2015 concerns that could continue to influence the 2016 economic and investment outlook  

  1. Oil and commodity prices. Commodities – especially oil – have been in a prolonged slump largely due to oversupply and a rising dollar. Don’t count on this to change anytime soon. Oil supply is expected to expand again next year, demand will likely continue to fall, and the dollar should continue to rise albeit on a much more muted basis. The upshot: avoid commodity exposure for the time being.
  2. High valuations. In general, stocks are fairly or slightly overvalued. Just as in 2015, it is unlikely that stocks can rally without underlying company earnings improving. For this to happen, the consumer and businesses must spend more – a possible outcome of a continued decline in unemployment and an increase in wages. The consensus is for modest profit growth, which would translate into single digit increases in stock prices.
  3. Expectations of rising interests. Some feel the Fed moved too soon; others that it moved too late. The fear? Inflation will raise its head and the Fed will have to raise rates faster than is healthy for the economy. Our view is that incremental increases in interest rates can be monitored by the Fed and handled by the economy.
  4. Technical signals: lack of breadth and a weakening A/D line. Technical analysis is warning of a potential downturn in the markets. There is a lack of breath (stocks participating to the upside), and the advance/decline ratio (rising stocks compared to falling stocks) is weakening. A healthy market needs more breadth. If these indicators continue to weaken, the likelihood of a significant pullback increases.
  5. Global Growth. The general consensus is that the upside for global growth is limited. The immediate outlook for emerging markets, especially the commodity centered countries, is especially cautious. China’s outlook is increasingly important for market sentiment. A little bit of bad news goes a long way. However, plentiful liquidity, seasonal factors and budding corporate profits in developed markets could make for a positive year for the more advanced economies.

 

We will add one unpredictable factor: politics. In the US it is an election year, which is (almost) by definition a negative influence, if for no other reason than the candidates hardly ever have something positive to say about each other. Overseas the geopolitical dynamics are complicated and multi-faceted. The potential for policy mistakes, conflict and surprise election results could throw off any path to recovery, as it has several times in the past.

So where is the cheer?

Little potential for a bubble, a recession or a credit crisis in the US. That means that while shorter term volatility is to be expected, a prolonged downturn is not anticipated.  Marginal returns, as we saw in 2015, usually indicate a lack of enthusiasm, but also no crisis pending. The good news is that historically market returns in years following those similar to 2015 are usually positive.

Favorable data in the labor and housing markets, low inflation, strengthening consumer and commercial credit, block buster auto sales and a stalwart consumer – all support continued steady US economic growth for the coming year.

 

Some take-a-ways for 2016 investors

Avoid the landmines. If you limited your investments in commodities and emerging markets in 2015, your portfolio probably avoided anything more than a very modest decline.  Continue the same strategy in the opening months of 2016.

Be willing to be late to the party. Even when commodities, emerging markets and other downtrodden asset classes appear to be breaking out, be cautious. Getting in too early may mean you have to endure another leg down. Any good party is one that lasts a long time. You shouldn’t miss too much of the festivities by coming sometime after the early birds.

Keep it simple. Many of the fancier alternative strategies underperformed this past year and were no bargain when it comes to expenses. Even the best of minds can be foiled by complexity and misguided bets. Don’t overpay, and understand what you own and why you own it.

Be selective.  Market sectors are not created equal and asset allocation matters. Even in years with benign market returns, such as 2015, the range of sector performance can be stark. In 2015 consumer discretionary stocks up  8.4% while energy stocks were down  24%. All you need are a few winners – and the ability to avoid the big losers.

Lower your expectations and plan ahead. Surprises to the upside can feel a lot better than those to the down side. Live within your means on a consistent basis, so you can allow yourself a reward when your finances pull ahead of your plans.

As for our outlook – we are adopting the “lower your expectations” approach when it comes to the markets. Even though we are hopeful that 2016 can be a promising year, we are not relying on optimism. As always, we will keep a watchful eye on the data and adjust our clients’ portfolios as economic winds and trends unfold.

Have a joyous and prosperous New Year.

Betsey A. Purinton, CFP® is Managing Director and Chief Investment Officer at StrategicPoint Investment Advisors in Providence and East Greenwich. You can e-mail her at bpurinton@strategicpoint.com.

The information contained in this post is not intended as investment, tax or legal advice. StrategicPoint Investment Advisors assumes no responsibility for any action or inaction resulting from the contents herein. Betsey’s opinions and comments expressed on this site are her own and may not accurately reflect those of the firm. Third party content does not reflect the view of the firm and is not reviewed for completeness or accuracy. It is provided for ease of reference.