A Tale of Two Years

2016 is off to a disastrous start, but before exploring the present, let us look back to 2015.  Very few investors increased their wealth in 2015.  The table below shows the returns of major asset groups for 2015 and 2014.

 

In the equity world, only the large-cap US stocks posted a gain.  Small-cap stocks and international stocks lost money, and commodities got hammered.  Bonds gained less than 1%.  The broad indexes only tell part of the story, however. 

The S&P 500, which represents the 500 largest public companies in the US, is a capitalization weighted index.  This means that each company in the index is weighted according to its total value (number of shares outstanding times the share price).  At the end of 2015, the 10 stocks with the largest capitalization were Apple, Microsoft, Exxon, Johnson & Johnson, General Electric, Berkshire Hathoway, Wells Fargo, Amazon, Facebook and Google.  Those 10 stocks make up 17.63% of the S&P 500’s returns. (The 10 stocks with the smallest capitalization make up 0.12% of the index.)  The top 10 stocks returned 2.90% for 2015.  The other 490 stocks lost 1.52%. 

In 2014, the top 10 stocks in the S&P 500 returned 2.61%, but the other 490 returned 11.08%.  Looking deeper into the S&P 500 for 2015 and 2014, we can see other interesting differences between years.  In 2015, less than half the S&P 500 stocks had positive returns for the year.  In 2014, more than 75% of the S&P 500 stocks had positive returns.  Stocks with values above their 200 day moving average are generally considered to be in a bull market while stocks below their 200 day moving average are considered to be in a bear market.  In 2014, only 24% of S&P 500 stocks were below their 200 day moving average, but in 2015, 57% of S&P 500 stocks were below their 200 day moving average. 

Even though the S&P 500 index managed to eke out a 1.25% gain in 2015, the underlying performance of most of the stocks in the index was very weak.  Two questions need to be addressed:

  1. Why were stocks so weak in 2015 (continuing their downturn in 2016 with the worst first week start to the year in history)?
  2. What does 2016 portend for stock returns and / or losses?

What happened to the Stock Market in 2015?

Here are some possible explanations:

  • China
  • Global unrest
  • Fear of Hillary
  • Panic over Trump
  • Federal Reserve policies

Not to sound like a conspiracy theorist, but I think the real issue in 2015 was the result of the Fed’s policies since 2008.  For many good reasons, the Fed began a series of policy moves known as Quantitative Easing (QE).  These policies, through the purchase of bonds, put new dollars into the economy and kept long-term interest rates low.  The effects of QE were to increase asset prices (stocks and real estate) and increase economic activity.  QE ended in October 2014, and the world waited for the next step – an increase in interest rates from the Fed.  The first increase came in December 2015.  While there are other more complex issues that have influenced the US and worldwide economies, the ending of QE and the beginning of interest rate increases have led to weaker economic growth and the resulting weaker corporate profits. 

This chart of the Weekly Leading Index shows strong economic activity through mid-2014 followed by a gradual decline into 2016.

2016 Guess

I have read many scenarios for 2016.  They range from a recession and ugly bear market to a resumption of global growth and a roaring bull market.  There are many more negative forecasts than positive.  At this point, with the first eight days of trading in 2016 leading to a 7.5% decline in the S&P 500, there are more questions than answers:

  • Will China increase its service economy in time to offset its struggling export economy
  • Will the US dollar continue to appreciate against the major world currencies, thus causing oil to continue its drastic decline, overseas profits of US multinational companies to decrease, and foreign countries and companies to struggle to pay their US dollar denominated debt?
  • How many rate increases will the Fed make?
  • Can Apple excite the public with iPhone 7?
  • Will consumers begin spending their energy savings instead of paying down debt?
  • Will the new President and Congress adopt a pro-growth tax policy to increase economic growth beyond the 2% we have seen for the last seven years?

Until we know the answers to those questions (and a lot more I have not considered), no one knows what the market will do in 2016.  We are, however, due for a short-term bounce up simply because the market has declined so rapidly.  Since the last peak on December 29th, the S&P 500 is down 9%.  Investor sentiment has become very bearish, the put /call ratio is extremely high, the fear ratio (VIX) is at highs not seen since the August melt-down, etc. 

Below is a chart of the S&P 500 that shows the new potential range.  Support is at 1860 to 1880 and the old highs are at 2130.