The start of a new year is always a good time to review one’s investments. Certainly someone should look at his statements more than once a year, normally at least quarterly, but the onset of a year is certainly a good time for a more thorough review.
Looking back at 2015, it was a year in which most financial assets were virtually unchanged. The broad based S&P 500, developed foreign markets, high-grade bonds, and money market funds all returned around 0 for the year. This means that people who had well diversified portfolios had returns that were close to break even for the year.
For those who undertook more risk, with the exception of the NASDAQ market, which was positive, returns were generally negative. Emerging markets were down in double digits, while small and mid-cap stocks had modest losses, along with high yield bonds.
There were several reasons why returns were essentially zero for 2015. Going into the year with stock prices at relatively high levels, economic news and corporate profits needed to be quite good for stocks to advance further. Economic news for 2015 was generally mediocre, while corporate profits were disappointing due to a strong U.S. dollar, weakness in a number of countries, and a major shortfall in earnings for energy stocks.
Fixed income or bond returns were lackluster for 2015, since interest rates started the year at already low levels, and would have had to decline further to get capital appreciation for bonds. Since interest rates stayed fairly constant for the year, bond market returns were quite low.
As we start 2016, there will be some differences relative to what occurred last year. At the end of 2015 the Federal Reserve finally raised interest rates, though only one quarter of a percentage point. Most likely short term interest rates will be raised at various points throughout 2016, though they will likely finish the year in the 1 percent range.
Oil prices continued a major drop in price last year, which started in the second half of 2014. Most likely oil prices, if not at a bottom, are quite close to one. At current prices, oil production is not economical for many U.S. and Canadian producers, so expectations are that oil prices will start to advance again.
How long it will take before prices start to rise again is an unknown.
One area where there was some improvement in the economy last year was the labor market, as unemployment continued to fall. Most likely the unemployment rate will not fall much further in 2016, but wage gains may be a little better versus what we have seen in recent years. Higher wage rates could be a negative for businesses, unless productivity starts to improve.
Looking forward this year for financial assets the outlook is mixed. The stock market is still relatively expensive, since corporate earnings actually fell last year.
However, the earnings weakness we saw last year was due to the collapse in the energy sector, and the impact of a strengthening U.S. dollar. These two factors will not likely be repeated again this year.
A rise in interest rates will allow for a small return for people with savings and money market accounts. However, a 1% return will not keep up with inflation. Returns from bond funds will likely be rather low, especially if longer-term interest rates rise, which would cause some loss in principal.
Someone might think, if 2016 isn’t looking much better than last year, then maybe there isn’t much to be gained by investing in financial assets. For example real estate in our area clearly did better than the stock market last year.
While real estate is a perfectly fine investment, it doesn’t provide the liquidity that financial assets do. In addition financial assets provide additional diversification. If our region suffered a major earthquake, and someone had all their wealth in real estate he/she would incur a major loss.
Most years people invested in financial assets will achieve a positive return. That would be the expectation for 2016. Returns going forward will likely be less than what was experienced in recent decades, but investors over time should make money with a well-diversified portfolio.
Foreign markets, especially emerging markets, have lagged U.S. markets in recent years. For someone who does not have much in the way of foreign holdings this would be an opportune time to add to this area. Emerging markets, while appearing attractively priced, are not suitable for those with a low tolerance for risk, or a time horizon that is not particularly long.