There is a saying “May you live in interesting times” and we sure do, at least when it comes to the financial markets. The first week of 2016 was the worst start to a year in the history of the S&P 500, down 6%. This put the market back into correction territory (10% or more drop from its highs) where it was for a short period of time in August. Interestingly, the more volatile Russell 2000 small cap index is down 19.2% from its high. Many people consider a drop of 20% or more to be indicative of a bear market.
So where do we go from here? Well, if history is an indicator then we have a fifty-fifty chance that the market will be higher at the end of 2016. Since 1950 there have been 24 times that the S&P 500 was down at the end of the first five days of trading and in 13 of those times (just over half) the market ended the year up. However, history does not drive markets; fundamentals, the economy and investors’ emotions do. Outside the U.S. all three of these things are a concern, especially in China and the Middle East. In the U.S., however, we see the economy as generally sound and growing; and fundamentals, while high on a historical average, are not out of line with where we are in an expanding economy. Emotions of course are another matter! Experience tells us that while investor sentiment and emotions tend to drive short-term volatility, over time it is the economy and fundamentals that will drive the market.
Trying to time the market is often difficult, if not impossible, because it is driven so often by emotions and a herd mentality. I do find, however, that investors are often rewarded for purchasing quality companies when others are selling. One of my favorite quotes from one of the best investors of our time, Warren Buffett, is “Be Fearful When Others Are Greedy and Greedy When Others Are Fearful.” January has clearly started off as a month when many are fearful.
So where to focus today?
As always it is important to evaluate your individual portfolio for adequate diversification to asset classes, stock and bond sectors, and regions of the world. Within an adequately diversified portfolio and accounting for your particular time horizons and risk appetite I like and would therefore overweight:
- US Equities – at current interest rates and with an expanding US economy it is better to be an owner than a lender. Within US Equities we suggest overweighting:
- Technology – this sector continues to change and benefit society at a scale at least as great as the industrial revolution;
- Financials – as interest rates rise there are many financial services companies that should see their profit margins increase;
- Health Care – many baby boomers will live to 100. Medical technology and health care is allowing senior citizens to live more fulfilling and longer lives. The companies that are providing and developing these solutions will likely benefit greatly from this reality;
- Defense – terrorism is changing the face of what military and defense products governments are buying, but they are buying. Global terrorism is not going away in the near term and is only accelerated by what is going on in the Middle East and the high unemployment rates in many developing counties for males between the ages of 15 and 30.
- Adjustable rate debt – as the Federal Reserve (the “Fed”) raises interest rates (we expect at least two more rate hikes in 2016 and the Fed is projecting four rate hikes) “fixed” income will be challenged. Also, as we have been saying for a long time, it is important to stay on the short end of the yield curve.
- For municipal bond investors quality is important. There are a number of states and cities that if they were companies would be bankrupt and while it is possible that a growing economy will bail them out, I am fearful of at least one or two more “Puerto Rico” like defaults.
We often tend to take recent experiences and project them into the future. As was pointed out by Ben Levisohn in Barron’s this week, we have just finished a two-year period with extremely low volatility as measured by the VIX (an index that measures volatility). Quoting Pravit Chintawongvanich he notes:
From 1990 through 2014, the market’s so-called fear gauge spent nearly a third of its time between 20 and 30, says Pravit Chintawongvanich, head derivatives strategist at Macro Risk Advisors. In 2013, however, the VIX spent just 1% of its time in that range, and in 2014 just 5%. As a result, when the big moves come, it “feels like the world is ending,” Chintawongvanich says. “In retrospect, the volatility is normal.”
Wishing each of you a blessed and prosperous 2016.
Susan McGlory Michel
Disclosure: This commentary is furnished for the use of Glen Eagle Advisors, LLC, Glen Eagle Wealth, LLC and their clients. It does not constitute the provision of investment advice to any person. It is not prepared with respect to the specific objectives, financial situation or particular needs of any specific person. Investors reading this commentary should consult with their Glen Eagle representative regarding the appropriateness of investing in any securities or adapting any investment strategies discussed or recommended in this commentary.