April 2016

All and All – Not Much

A Quarter with Little to Offer

Sometimes I just hate looking back. However, looking back and looking forward are parts of my job. Starting with the first quarter of this year, the S&P 500 stood at 2044. At the end of the quarter, it was at 2064, or 20 points higher. That was a gain of almost 1%. For the entire year of 2015 the S&P lost 1%. Now let’s put this all in perspective. At the beginning of 2015, 15 months ago, the S&P was at 2059. At the end of March 2016, it was at 2064 or up 5 points, which is a blazing increase of 0.024%. Wow!!! Believe it or not, that compares favorably with bank interest rates on money markets and interest paying checking accounts. Of course, with those there is no risk. In the parlance of the market, we call this “the doldrums” or market apathy. Investors for more than the past year have been less willing to take on risk.

What’s The Deal?

Many of you have heard the story of my oldest granddaughter, on our way to Fenway Park for her first baseball game, asking me “What’s the deal?” Her mother had tipped me off on what this meant. She wanted to know what she could have when she got to the park. I answered, “A soda, a hot dog and a bag of peanuts.” Now she knew what the deal was and she could negotiate around these perimeters. She accepted the soda and hot dog but noticed they had cotton candy, which she found far more appealing than a bag of peanuts. I, of course, consented.

The point of this story is that we all want to know “what’s the deal?” Once we know what the deal is we can act accordingly. Investors fall into this category too. As investors, we need to have some idea of where the economy is going. What regulations might impact our investment? What is happening with interest rates? What is the state of earnings, dividends, share buy-backs and productivity of businesses? How is the consumer spending? What is going on internationally? What conflicts in the world might impact my investments? What is happening to commodity prices? This list could go on and on but the fact is that for more than the past year, getting answers has been very difficult on all fronts.

Reducing Risk

How do you reduce risk and hopefully make some money in this atmosphere? At present, we are in a very low interest environment. What this means is that the safety of bonds in our portfolio mitigates risk, but we don’t earn much. Stocks can produce good gains, but they go through periods of little or no growth to actually going down in value. If we went back to August of 2011, we’d find the S&P 500 at 1129. By May of 2015 it had reached 2126, for an increase of 997 points or an 88% gain. During this time there was very little volatility as the market progressed upward. Since that time we have had a great deal of volatility. From a technical perspective, the market had three major drops, testing the downside during the past 15 months, and recovered from each. We are currently above the 200-day moving average. From a technical standpoint, the stock market appears to be in a position to begin a new climb upwards.

The Past is No Guarantee

Humans have a tendency to take what they have just experienced and extrapolate into the future. By this logic, therefore, if the stock market has not delivered meaningful results in the recent past, it will not deliver meaningful results going forward. When you really think about it, you know this not a reasonable proposition. To look at the stock market in a manner that allows for some sense of long-term understanding, we generally turn to technical and fundamental analysis. Technical analysis is what was described in the section “Reducing Risk.” Fundamental analysis deals with looking at the consumer, seeing what is actually happening at corporations and the state of the world economy. Currently, we are in the reporting season for first quarter earnings. My overall expectation is that they will not be as good as first quarter 2015. My expectation is that, as the year progresses, we will see this change and the consumer will begin to spend more. I believe that all of this will come together in the fourth quarter of 2016.

The stock market is a leading indicator of where the economy is going in the next three to six months. With this in mind, we should see the stock market getting stronger during the summer and into the fall. This would be indicated by rising prices on stocks.

World Market

The world is in a great deal of unrest at this time. It is hard for us in America to understand the violence that is taking place in other parts of the world. Unlike thirty years ago, the impact of world events is now in our own backyard. Economies in other parts of the world impact the value of the securities in the U.S. This past quarter, small investors in China were selling their stocks and this action brought down stocks all over the world, although many, like the U.S., had little that would be impacted by this shift. Last year China decided to devalue their currency and botched the job, also creating an adverse affect on markets around the world.  That is likely to happen again and again. When oil prices dropped, we heard that this was bad. As they began to move back up, we heard this was bad. What is the truth? There are long-term market developments and short-term developments. You can’t invest by reacting to short-term developments unless you think they will actually lead to fundamental long-term changes.

Diversification

For years I’ve recommended, and continue to recommend, diversification. Diversification helps reduce risk and maintain stability in a portfolio. It is not a guarantee to make money but it is a way to stem losses and participate in overall market gains. In looking at many of our clients’ portfolios, I’ve noted that they have done as well or better than the stock market over the past 15 months. I can’t say that I’m excited by the results, but most did not participate in the extreme volatility of this period because of diversification.

Conclusion

A level of stability is apparent in the markets at this time. The Federal Reserve has indicated that they will raise interest rates no more than twice this year for a maximum of 0.50%. The U.S. economy, while not on fire, is moving consistently ahead in new hires and increased productivity. The consumer has been saving and paying down debt and appears to be in a position to spend again. Other major countries in the world are working on shoring up their economies. The value of the dollar is dropping, putting U.S. business in a better position to sell products overseas. All of this is beginning to give investors a sense of what the deal will be going forward in 2016.

Ed Mallon