A brief note about the Paris attacks
A night of horror in Paris, similar to attacks in Spain in 2004. London in 2005, Moscow in 2002, Mumbai in 2008, Boston in 2013, Oklahoma City in 1995, Columbine in 1999, the Munich Olympics in 1972. Terrorist attacks killing dozens are nearly daily occurrences in Iraq and other Arab nations. The common characteristic of these attacks is not so much a particular religion but a particular kind of attacker - "losers" - young men alienated from society by lack of economic and marital prospects decide that a spectacle of death will provide the transformative event leading to utopia. Alas, no. Simply a pile of bloodied and broken bodies. These events are human tragedies, not economic tragedies. We grieve for the victims as people, but we don't change our positions as investors.
Monster October Stock Market Rally Not Sustainable in November
US stocks rallied 8.5% in October (best month in 4 years,) lifting stocks 12.2% off the summer lows and to within 1% of the May 2015 record high. From November 4th, stocks declined 6 of the last 7 days, which makes investors wonder if we're heading back to those summer lows: With 7 weeks trading weeks remaining in 2015, the S&P 500 is virtually unchanged with a gain of 0.08%. Our price target for the S&P 500 for 2015 is a gain of 6% - still achievable.
Our full report of market indexes is here. A number of our clients have noted that their portfolios are doing particularly poorly this year relative to the benchmarks, in some cases as much as 5% below. Terrible, right? We should change our strategy, right? Not necessarily. For 22 years we've pursued an all-cap strategy that over-weights certain high performing sectors such as healthcare, financial services, and technology while under-weighting lower performing sectors such as utilities and consumer non-discretionary. We mix in bonds of varying credit quality to provide stability and reliability of income, and we generally invest 10% of client's assets in internationals stocks of developed markets, 5% in emerging markets. We believe this asset allocation provides a reliable stream of "base hits" - stock positions that will likely provide a reasonable return for the amount of risk we're taking. We rarely stretch for "home run" investments; such investments have a much higher probability of "striking out."
All good, but a negative return is still a negative return. Why are we not making any money this year, and is there ANY way of doing better?
On the bond side, it seems clear after last week's jobs report of 5% US unemployment, that the Fed will raise rates to 0.25% in December. Given that the "real" unemployment rate is closer to 10% and that neither wage nor goods inflation exceeds 0.2%year, it seems highly likely that the Fed will NOT raise rates to 0.5% until well into 2016. However, bond investors panicked already at the prospect, thus a sharp decline in bond prices over the last month. For the year, the aggregate bond index is up only 0.5%. In most years, we can expect our bond portfolios to deliver 3-5% total return - not this year.
On the stock side, energy stocks are in pronounced bear market since August 2014, and are down 15% since the start of 2015. Investors worried for a decade about "the end of oil" and permanently high prices. Clever American engineers found a way to "frack" oil and natural gas out of old US wells. Initially, the oil had to be over $70/barrel to cover the cost of production, but now the breakeven is as low as $50/barrel. In July 2014, oil was still over $110/barrel, fell to $50 by January 2015, rallied back to $65 by May, then dropped below $50 this fall, closing at a multi year low of $44 last week.
Ironically, the lower oil price goes, the more oil Saudi Arabia, other OPEC nations, Russia and Venezuela will pump. These countries are desperate to maintain revenue and market share. Saudi Arabia in particular would love to see the US fracking market die off (the US was poised to become an oil net exporter.) What will happen instead is that current fracking wells will exhaust over the next year, but few new ones will be drilled. As supply comes into line with demand, prices will firm dramatically. By then, a number of fracking drillers will have gone into bankruptcy, so rebuilding US capacity will be slow. In other words, enjoy $2/gallon gasoline now, because a year from now it could be $3.
Other poorly performing sectors include:
- materials down 7.1% YTD on reduced Chinese demand
- utilities down 7.5% on interest rate worries
- industrials down 2.5% on reduced international demand, currency translation on earings
- financials down 1.9% on interest rate worries
- telecommunications down 1.7% on interest rate worries
There are two bright spots - info technology up 4.6% and consumer discretionary up 9.0%. We're in the midst of a substantial technology upgrade cycle for both consumers and businesses, so we understand that. Consumer discretionary stocks are doing OK except for one company - Amazon - which is having an amazing year, rising as much as 130% YTD. Take that stock (6th most valuable company in the S&P 500) out of the index, and consumer discretionary looks no better than the other major sectors. Overall, more than half (290 out of 500) of stocks in the S&P 500 are negative on the year.
International markets deliver wildly variable returns this year. The MSCI EAFE index, which includes most of the world's stock markets but excludes the US, is down 0.6% so far this year. Germany France and Japan are having excellent years, but the winner is the Shanghai index, up 56.6 YTD and up 28.5% since October 1st. Wasn't the Chinese stock market the source of our anxiety just a few months ago?
You can't make money every day in stocks, and not even every year
We've often described the stock market as an incoming tide - individual waves may slosh water back and forth, but by the end of the afternoon, the tide is at the top of the beach.
We have S&P 500 return data running back to 1928. There have been plenty of times when the waves sloshed out (1929-1932, 1939-1941, 1973-1974, 2000-2002, 2008-2009) but 73% of the last 87 years, the S&P 500 returned positive numbers.
What is particularly important to note is that truly horrific bear markets as we saw in 2008-9 occur (on average) once a generation. The fact that we experienced two such bear markets in the last 16 years is the reason why so many investors remain skeptical about stocks. Returns of the S&P 500 over the last 16 years are exactly half the 87 year average. Skepticism about stocks is expensive however. Even Investors who invested January 1st, 2000 or January 1st, 2008 still made 85.3% over 16 years, 52.3% over the last 8 years.
As we roll into 2016, the negative impact of interest rate increase will be absorbed, while earnings should pick up after the current slow patch. The other uncertainty facing investors, the US Presidential election, will obviously resolve itself on November 8th, 2016. On the Democratic side, it seems unlikely that anyone but Clinton will be the nominee. On the Republican side, the final four appear to be Trump, Carson, Rubio and Cruz. Bush, who led the polls through July, is increasingly irrelevant. Paul, Kasich, Fiorina, Huckabee, Christie, Santorum, Jindal, Pataki and Graham are polling at or below the polling margins of error.