Market Commentary

Plus ça change, plus c'est la même chose

(The more that things change, the more they stay the same)

January 2016

"Those who cannot remember the past are condemned to repeat google it." – George Santayana

The financial press at this time of the year is littered with predictions and prognostications, most of which are forgotten sooner than our New Years’ Resolutions. For most predictions that is probably a good thing, but reviewing where we’ve been can prove to be a useful exercise in self-assessment, and helpful in shaping our outlook for the coming year and beyond. George Santayana did not enjoy the benefits of the internet when he cautioned about the risks of ignoring one’s history. Now, trolling through past predictions is just a click away. George never had it so good.

Just over a year ago Barron’s magazine published its 2015 Outlookⁱ "Wall Street’s top strategists expect the S&P 500 to rally 10%" it proclaimed. There was "…no dissent on the market’s future direction. That owes…to a dearth of attractive alternatives." The most pessimistic prediction for the market index was 2100 and the most optimistic was a high of 2350. Closing the year at 2,044, even the most pessimistic Wall Street market strategist proved to be too optimistic.

Later the magazine trumpeted "Five Oil Stocks to Buy Now."ⁱⁱ The price of oil had been cut nearly in half in 2014 and was attracting the attention of bargain hunters. All five stocks suffered price declines in 2015. The best performer of the five stocks touted in that Barron’s – Occidental Petroleum - declined 18% last year, and the worst – Royal Dutch Shell – plunged 35%. These examples are not intended to be an indictment of Barron’s (or any other financial publication for that matter). They serve as a gentle reminder how humbling predictions can be.

So where were we at the beginning of 2015? In our January Market Commentary we outlined "(t)wo things…that we think have set the stage for an increasingly turbulent time (in) 2015." The first was the impending – or so we thought – increase in the Fed Funds rate by the Federal Reserve. We postulated that an increase in interest rates would strengthen the dollar and "cause disruption." The rate increase was highly anticipated by the market, so we did experience meaningful market volatility throughout the year, even though the Fed did not see fit to begin unwinding its overly accommodating interest rate policy until December.

Secondly, we expressed concern that unprecedented levels of global monetary stimulus had "let to a lot of cheap money chasing return." We have been concerned about the risk visible in various market and economic data points for many years now. That concern has led us to keep your portfolios positioned very cautiously; keeping bond durations short, equity allocations light and defensively focused, and adding exposure to hedges against problems in the financial system.

Those risks we expected, however, they manifested in a way that we did not anticipate. High flying technology stocks that we viewed as unconscionably expensive pushed even higher. The top two performing stocks in the S&P 500 last year were Netflix and Amazon, both of which more than doubled, reaching valuation multiples of nearly 300 times earnings for Netflix and over 900 times for Amazonⁱⁱⁱ We remain concerned about pockets of risk in the market. Overall, we saw a few high valuation stocks create a rather bifurcated market. We remain concerned about pockets of risk in the market. The Morningstar US large Growth Index gained over 7% in 2015, while the US large Value Index declined about -1.4%. Large Cap Growth Equities was one of the few asset categories that worked last year, which may explain why the majority of investors lost money in 2015.^iv

Our value philosophy remains the same: we continue to seek long-term investment opportunities at valuations that create opportunity for gain. In addition, we want to both ensure adequate allocation to broad areas of the market in order to reduce portfolio risk, and also reduce portfolio costs where they don’t lead to additional return. We have seen historically what happens when investors chase performance; it usually ends badly. While we are frustrated with recent performance, we are confident that remaining disciplined in our approach is the appropriate course of action.

Ultimately, we can’t predict the future, and we take very seriously our responsibility to avoid permanent loss of capital in our clients’ portfolios. We continue to have a good deal of conviction that there is an excess of risk in the financial system and global economy, as evidenced by recent global market volatility induced by chaotic Chinese stock market trading. In this context, we will continue to be thoughtful and deliberate about investment decision making and portfolio asset allocation.

By the way, Barron’s recent 2016 outlook issue reports that Wall Street strategists are once again calling for US equities to head higher over the coming year. Sound familiar?

This is a general assessment of client portfolios and does not reflect the specific circumstance of every client.

i - Barron’s Magazine, December 15, 2014
ii - Barron’s Magazine, December 22, 2014
iii - Valuation multiples from Yahoo! Finance as of 1/5/2016; P/E ratio (ttm): Netflix 285x, Amazon 911x.
iv - CNN money, 12/31/2015, "Nearly 70% of investors lost money in 2015". money.cnn.com/2015/12/31/investing/stocks-market-2015
v - Barron’s, December 14, 2015