As 2015 comes to a close, we reflect on the turmoil that we witnessed throughout the year. It has been intensifying. Volatility is rising. With the exception of Japan and, less so, some in Europe, developed markets are flat or down this year-to-date.
We will use year-to-date total return (closing prices plus yield) through December 22. SPY, the US equity ETF for the S&P 500 cap-weighted index, had a total return of 0.75%. The equal weighted ETF for the same 500 stocks is RSP. Its total return was -3.42%. The worst performing sector ETF was in energy. XLE was -23.29%. ACWX is the iShares MSCI global index without the US. Its total return is -5.74%. ACWI includes the US and holds over 1200 stocks in developed and emerging markets worldwide. Its total return through December 22 was -2.42%.
Central bank uncertainty is part of the reason for poor performance. One factor is the Federal Reserve’s (Fed) finally raising interest rates a quarter of a point. The inevitable lift-off from the zero lower bound has arrived after what Nariman Behravesh, Chief Economist at IHS, labeled the “longest monetary policy drum roll in history.” As the US raised rates, the European Central Bank lowered theirs to an even more negative level while expanding the types of securities it will purchase. And Japan expanded its use of purchased ETFs.
No wonder volatility rose. Divergences cause volatility. Widening divergences intensify it.
There is now turmoil in both the Energy sector and commodities. There is growing concern about default risk in the high-yield sector of the market. See our Bloomberg TV interview on High Yield and risk. Here is the link. http://bloom.bg/1IkXqhI. We have written about how high-yield problems extend beyond the Energy sector debt. Some mutual funds pumped up their reported yields by using foreign securities with currency hedges. The strategy has backfired on them
Violent moves in currencies continue to affect stocks, bonds, and financial markets throughout the world. The volatility in the Canadian dollar versus the US dollar is a good example. Americans tend to overlook Canada, even though it is a large trading partner of the United States. The loonie (Canadian dollar) has had its worst year ever. The two currencies were at par as recently as December 2012. Today, it costs at least $1.40 Canadian to buy a greenback that could have been swapped one-for-one with the loonie three years ago.
US stocks enter 2016 on the heels of a volatile close that raised risk aversion for investors. How 2016 unfolds is problematic. Our best guess is a mid-single-digit total return.
The biggest driving force for worldwide asset prices continues to be very low interest rates as we enter the new year. The worldwide short-term interest rate averages less than 1%, with a large contingent in negative interest rate territory. That is the case even after the Fed hiked rates a quarter point at its December meeting.
Worldwide bond interest rates range somewhere between 2–3%. Many jurisdictions are much lower or in negative rates. That is now 22 countries in Europe and over $2 trillion trading at negative rates. Those bonds are denominated in four currencies
There is an upward bias in asset prices when interest rates are persistently low for long periods. That upward bias has been in place since 2009 and continues into 2016. There is nothing on the horizon suggesting that interest rates will do anything in 2016 other than remain very low. Low interest rates are bullish for assets including the US stock market, real estate, and collectibles. Also included is any other type of asset class in which a discounting mechanism and a very low interest rate influences the price.
At Cumberland Advisors, we enter 2016 nearly fully invested in our US stock ETF portfolios. We have a small cash reserve. We are diversified among sectors and have biases away from the troubled sectors. Some are now so cheap, however, that we are nibbling at them. Natural gas is one of them. Everyone hates it. But the first LNG exports are starting to happen, so volumes are going to rise. We think the time to buy a sector is when no one wants to own it.
We are particularly optimistic about housing and its recovery in the United States. We reflect that position in our US ETF portfolios with overweighted positions. For a superb discussion of the housing market outlook, see Nationwide’s Health of Housing Markets (HoHM) Report.
An election in 2016 provides Americans with the opportunity for a debate on US policies. It is the nature of our political system to also provide entertainment. Both serious conversation and political folly are in the cards for 2016.
In the end, America’s institutional strength weathers the changes in political regimes. If we think about the world in the context of politics, we witness the fact that we peacefully change presidents, hold congressional elections, and alter 50 state houses. We do it in a ballot box, not with guns and tanks. Our institutional strength in the United States is second to none in the world.
So, please vote in 2016. And remember that your vote in a primary election has great value. That is where the candidate choices are decided.
Happy holidays and our best wishes for a healthy New Year. Stay safe.
David R. Kotok, Chairman and Chief Investment Officer