4Q15 Market Overview
The last 12 months tested the patience of long-term globally diversified investors. As we started the year, the wall of worry initially focused on energy’s precipitous 60% decline and a robust U.S. dollar which weighs heavily on the earnings of U.S. multinational companies. In August, the fear reached a boiling point when attention turned to China’s economic slowdown.
Once again, the sharp third quarter pullback was overdone and global equity markets proved exceptionally resilient in the face of uncertainty and quickly recovered losses to finish the year relatively flat. The bounce back is ever more impressive when considering the Fed’s historic decision to raise the interest rates in their December meeting.
As we begin the New Year, volatility and emotional selling is likely to persist as investors react to disturbing Chinese headlines and attempt to quantify China’s diminishing contribution to global economic growth. Domestically, we are encouraged by the Federal Reserve’s guidance and general direction. So far, they have been successful in removing stimulus and will now carefully consider the velocity of future interest rate increases. If economic conditions continue to improve, we can expect gradual interest rate increases of roughly 1% in 2016.
Looking forward, we will continue to take advantage of diverging market trends by rebalancing to target allocations while maintaining your desired risk level and fulfilling your cash flow needs. This process typically involves harvesting gains or losses in the most tax-efficient manner possible and then re-allocating the proceeds to out of favor asset classes that offer more attractive long-term opportunities such as international equities and bonds.
U.S. Equity Markets
The U.S. equity markets surged in October and then limped to the finish line to close out a positive quarter; the Russell 3000 return was up 6.3% for the quarter and an only .48% for the year. Growth stocks outpaced value stocks by a wide margin in 2015 with health care leading the charge. According to the Institute of Supply Management (ISM), manufacturing weakened a bit in the second half of the year and moved into contraction territory for the first time in three years. Other notable movements included a 25% pullback in Bloomberg’s commodity index and continued dollar strength which made exports more expensive. Fortunately, the labor market remained healthy and the services economy (which represents 88% of U.S. GDP activity compared to 12% for manufacturing) continued its expansion phase and helped the U.S. economy grow at an annualized pace of 2% from September to December (according to the U.S. Department of Congress). Consumers are feeling the benefits of the abrupt decline in fuel prices which should slightly improve overall GDP growth.
International Equity Markets
International developed equity markets returned 4.7% for the quarter and modest annual loss of .81% for the MSCI EAFE. The U.S. dollar gained additional ground against most major currencies to close out the year which inflicted further damage to dollar-based investors. This pain was felt the most by U.S. investors in Europe who lost 2.8% during 2015. Given Europe’s anemic inflation, the European Central Bank (ECB) announced an extension of its current stimulation program to boost their recovery. Japan’s ambitious long-term turnaround plan helped elevate Japanese profits and resulted in a healthy 9.6% market return. China’s volatility continued to overshadow the markets as they transition from an export to consumer-driven economy. This volatility is likely to continue as the Chinese government tries to stimulate internal growth to avoid a hard economic landing. Although China was a bright spot in emerging markets, the MSCI EM was down 15% for the full year as commodity driven economies, such as Brazil, lost 41% of its market value and weighed on the asset class. After three consecutive years of underperformance relative to the U.S. markets, both developed and undeveloped international markets look much more attractive for patient long-term investors who can take advantage of the dollar strength to buy in at lower prices in anticipation of a reversal of these trends.
Fixed Income Markets
Safety-minded investors lost ground during the quarter; the Barclays Aggregate was down .57% for the quarter and eked out a modest .55% gain for the full year. After the Fed finally raised rates for the first time in nine years, the 10-year Treasury yield rose during the quarter from 2.06% on September 30 to 2.27% on the final trading day of the year. Given the 21 basis point overall yield increase, the longest dated maturities posted more negative returns since their existing bonds became less valuable compared to newly issued securities. The Barclays US Government Long posted a 1.38% quarter loss, Intermediate .84% loss and Short .43% loss. The same trend played out on an annual basis since the 10 year treasury yield barely moved from 2.17% on January 1 to 2.27% on December 31. In the international fixed-income arena, the JPM Non-US Unhedged posted a 1.30% quarterly loss and more damaging 4.84% annual loss under the weight of an exceptionally robust U.S. dollar. The Barclays Municipal continued to reward tax sensitive investors trying to lessen the drag of new investment related taxes, gaining 3.30% during the year and shrugging off Puerto Rico default concerns.