As 2015 winds down on Wall Street, it’s always worthwhile to look back on projections from the beginning of the year. Alongside the binary outcomes of whether they were right or not, the logic is equally interesting to think about, and extrapolate whether it applies for the future. The key themes seen throughout? A divergence among monetary policies, a continued search for growth by investors, the rising influence of technology in consumer and enterprise behavior, a collapse in commodities, and crowded trades alongside increasing volatility in the broader market. Here’s our recap of 2015.
To date, the Dow has returned -3.9%, the S&P 500 has returned -2.6%, and the NASDAQ is up 3.9%. What could be the takeaways? The index with the smallest median market cap looks to have outperformed its larger peers. Growth seems to have outperformed value, and domestic firms fared better than the ones deriving more revenues abroad. Also worth noting? A handful of market cap giants, including Amazon, Facebook and Microsoft, have contributed a vast majority of each index’s returns. Excluding them, the numbers look far more bleak; the Guggenheim S&P 500 Equal Weight ETF, for example, is down nearly 5% YTD. Overall, earnings for the S&P 500 are flat for the year, while revenues are projected to have declined 3.4%, per FactSet. Not quite what you’d expect in the 7th year of an economic expansion and bull market…then again, the post-2008 era has been extremely unique amid near-zero interest rates, lower-than-historical average growth rates and a lack of worldwide inflation. Therefore, historical precedents may not be as applicable.
Anyway, back to 2015. At the beginning of the year, we outlined our bullishness on technology and biotechnology, as well as the consumer discretionary sector. The underlying logic alongside the details was that the first two sectors were less impacted by macro concerns, and were leading a structural market shift through innovation and entrepreneurship. Our ‘Why Technology Matters’ article in May summarized the thoughts. Both sectors have performed extremely well, up 2.6% and 9.3% respectively (with the IBB ETF representing biotechnology). Regarding consumer discretionary stocks, we felt that consumers were sitting on robust balance sheets and savings, and were well placed to spend. The recent auto boom as well as housing uptick shows this may be playing out; oil’s collapse has been another bonus. Consequently, the consumer discretionary sector – our favorite pick since January – is up 7.3%, the best performer of the year – and more gains may be yet to come in 2016, given spending has actually been pretty subdued so far.
Financials were also recommended in Q1 given a rising rate environment, and alongside, we highlighted cybersecurity stocks, amid an increasing need for firms to protect themselves (to put mildly – especially after seeing Sony’s hack). Both are underperforming the S&P 500 so far, with financials down 5.1% and cybersecurity down 3.9% (represented by the HACK ETF). The theses continue to apply for 2016.
On a broader note, we felt growth would outperform value. This proved out extremely well; growth-starved investors displayed resilience in rewarding the few stocks that have shown organic growth, with the Russell 1000 Growth index up 3.7% vs -6.3% for the value equivalent.
Another prediction was that small caps would outperform, given the US recovery and fragile international environment. According to the SBA, small businesses comprise over 99% of total US employers, and employ over 70% of the US labor force; with a proxy such as the Russell 2000, over 80% of the index’s revenues are derived domestically, according to research from the Bank of America. With a strengthening dollar further aiding our view, we felt this was a wise bet. However, this is yet to play out, with the Russell 2000 down -6.9% vs the S&P 500’s -2.6% – primarily due to expensive valuations to begin with. We feel the thesis remains intact, as again noted in our August 9th article. Another quote we continue to emphasize is ‘bigger is not always better’, given the era of execution efficiency shown by the previous 30 years’ multinational titans may be ending, in favor of more local, nimble, and simpler business models, as seen by the disruption in asset utilization, data-driven decision making, entrepreneurial culture, and idea-intensive companies worldwide.
The year’s headlines were dominated in phases by Greece, China, oil, the high yield bond market, and the Fed. We raised red flags on the high yield bond market and China (ex-consumption stocks) in the beginning of summer. Both stories have proved out pretty well. China’s call was largely driven by valuations and the overload of debt. A timely report by a Barron’s journalist on how farmers were shunning their jobs to day trade stocks was one of the memorable moments, considering the lessons learnt in the dot-com bubble around less sophisticated investors joining the uptrend late. Stocks there have since corrected, and are at far more reasonable levels today as the $11.4 trillion economy moves into a new development gear. Alongside, our worries around emerging market debt and currencies in light of a tightening US monetary policy remain high on the radar for 2016. On a separate note, an attempt to call a bottom on oil when it had reached the $40s (WTI crude/barrel) was futile; realizing the efficiency of this commodity market, it’s best to go with the flow and take the price given the complex supply and demand scenarios, with geopolitical nuances involved.
On a macro perspective, meanwhile, we predicted a stronger dollar, and an outperformance by Europe. Both came true, with the dollar index up 10% YTD and the Stoxx 600 up 5.5% YTD, albeit, in local currency terms; a conversion would wipe out the gains. From a country perspective, our favorites included Germany, Mexico, Indonesia, the Philippines, India and South Korea. While the time horizon on these is far beyond 1 year, so far, in local currency terms, we’ve seen mixed progress, with the indexes up 8.2%, 0.8%, -14%, -5%, -7%, and 3.1% respectively. Much of the downside ex-Germany can be attributed to the overall negative emerging market sentiment amid a tighter Fed; domestic fundamentals remain strong, although as with all emerging markets, time and again, it remains obvious that political news matters – substantially. We expressed serious caution around South Africa (in the short term), Russia, China, and Brazil for 2015; each except China has played out, delivering -2%, -3%, 10.6%, -9.5% respectively. In dollar terms, of course, these move substantially lower.
Alongside, we also noted that markets would face higher volatility, which would enable stock pickers to have a far better year than 2014, where less than 20% of active managers outperformed, per data from S&P Dow Jones Indices. That has certainly played out; this year, with data from the CBOE, the VIX has averaged around 16.4, compared to the 2014’s average of 14. Active outperformance is projected to be over 40%; we’ll have a more accurate number at the end of the year. We also projected that the IPO market would remain heated amid accommodative public markets, and M&A activity would continue to prosper amid a low growth global environment. The latter played out, but the former did not; IPOs are down 38% this year, per Renaissance Capital, and we feel good about it – the public markets are greeting sky-high unicorn valuations with serious caution, and that’s a very good sign against complacency. M&A activity, meanwhile, has shattered records, at nearly $4.3 trillion, per Dealogic, YTD. A key point to note is that the last time M&A activity reached relatively similar stratospheric levels was in 2007 and 1999, and what happened in each of the following years can be vividly recalled. At the same time, with our preference for long term investing, the thoughts above are essentially data points to think through as the multi-year time horizon unfolds.
We conclude with the 10-year yield, which started the year at 2.17%, and amid increasing equity volatility and a rising rate environment, have ended essentially flat, at 2.20% as of Friday; Wall Street had predicted higher rates by the end of 2015. Another key data point? Last week’s first rate hike announcement, in fact, was greeted by falling yields, interestingly, into the weekend. 2-year yields, meanwhile, started the year at 0.67%, and ended last week at nearly 1%. Given their higher sensitivity to Fed Fund rates, it will be important to keep an eye on the yield curve, and whether a similar continuation in moves leads to a flattening into 2016.
What it means for you: All in all, the S&P 500 finds itself at 15.7x forward earnings (given an earnings consensus of $127.66, per FactSet), and the NASDAQ at 19.5x, per WSJ data – certainly not stretched per historical averages. However, in a rising rate environment and amid serious shareholder friendliness addiction over the recent years, investors should exert significant caution while positioning for 2016. We’ll deliver our outlook on next year in the following week. Wall Street’s capital markets are entering a new era – one where the US is tightening but few others are, the emerging markets aren’t surging, and commodities are finding new levels alongside paradigm shifts in technology. Be prepared for what should be an extremely interesting – and insightful – year ahead in the financial markets.
