2015 looked a lot like 2011 – the equities markets got off to a solid start, experienced a correction during the summer months, but then couldn’t quite power through to new highs. It was a year of middling returns.
To experience a flat year (or years) within a bull market, however, is common and investors should not get discouraged going into the New Year. Global growth on balance is still set to be north of 2%, and earnings should recover as crude oil prices start to form a bottoming pattern. The stock market may not produce the 2013-type returns we all covet, but I believe it will still deliver modestly positive results. The overarching message: stay the course.
Looking back at 2015, there were five main factors that I think influenced the ultimately flat returns. Here they are…
Slowing Growth in China – the era of 10% GDP growth is long gone for China and 2015 could be the slowest growth the burgeoning economy has seen in a quarter century. Chances are that full-year growth will come in below 7%, which gives the market a healthy dose of anxiety. But, it shouldn’t. At the end of the day, China’s economy has essentially doubled in size over the last ten years and simple economies of scale tell us that super high growth rates simply aren’t sustainable. Additionally, we actually see China’s slowdown as a good thing – China is deliberately taking steps to restructure their economy to rely more on consumer spending and services versus investment and infrastructure spending. This is a wise move longer-term, but in the near term some of the once-darling industries suffer: the manufacturing sector has experienced falling profits and over 40 months of deflation, while industrial production grew at a slower pace than expected. Bright spots of 10+% growth still exist in fixed asset investment and retail sales. We expect China to grow in the 6.5% – 7% range next year, which is just fine. No reason to raise any alarms here.
Divergent Monetary Policies – for the first time in this economic cycle, the U.S. and the rest of the developed world diverged in their approach to monetary policy. While the U.S. raised interest rates for the first time since June 2006, Europe, China and Japan all took big steps toward continued easing. The People’s Bank of China lowered interest rates six times in the year to settle at 4.35%, the European Central Bank commenced its quantitative easing program in March (plans to run it through 2016) and the Bank of Japan maintained its pledge to increase its cash and deposits at an annual pace of 80 trillion yen ($662bn) through aggressive asset purchases. On balance, this should continue to provide support for risk assets, with low interest rates globally and plenty of liquidity. Although the U.S. is technically in a “tightening cycle,” they will raise rates only gradually and money is still easy.
Crude’s Decline and Energy’s Negative Impact on S&P 500 Earnings – oil prices commenced an epic slide during the summer of 2014, having fallen by well over 50% on waning demand (China slowing) and a supply glut that won’t abate. More than 200,000 oil workers have lost their jobs and manufacturing of drilling and production equipment has fallen quite dramatically. Several shale drillers/producers have gone out of business and high yield bonds and Master Limited Partnerships in the space have felt a real sting. The surge of U.S. production is part of the story, but OPEC has also resisted curbing production from 30+million barrels a day. OPEC is arguably doing this for two reasons: to put some U.S. companies out of business, curb U.S. production and also compete for business in the Asian markets. The shakeout has taken a considerable toll on Energy company earnings, which by extension is also pulling down aggregate S&P 500 earnings. In the second quarter of this year, total earnings for S&P 500 companies were down -2.1% from the same period last year on -3.4% lower revenues. However, if you strip away the Energy sector, total earnings for the S&P 500 would have been up +5.2% in Q2 on +1.3% revenues. Looking forward to 2016, we think crude oil prices should level off which will also help boost S&P 500 earnings in aggregate.
Stronger Dollar – the dollar has seen a major surge since summer of 2014 for a couple of reasons. The first is that the U.S. has experienced the most stable economic and earnings growth in the eyes of the world, and the second was the anticipation of the interest rate hike which finally occurred in December. A significant strengthening of the dollar can have a few effects, such as pinching earnings growth for multinationals who sell to countries with now weaker currencies. We didn’t quite see that effect yet this year, but it will be something to keep looking for. Another, more concerning effect could be on emerging economies, where businesses and governments have large dollar-denominated debts on their balance sheets. As financing costs rise, it could crimp future spending and maybe lead to some default issues. The market could have very well priced-in some of these factors this year.
European Uncertainties – Greece, the future of the euro, Britain’s membership in the European Union, refugee migrations and relocations, terror. Europe has had its slew of issues this year and where loose monetary policy has helped get the economic union moving again, these aforementioned issues have kept the headwinds blowing. Greece got its third bailout this year (after a lot of political chess wars) with loans of up to $95 billion over the next three years. Britain’s hot button political issue is membership in the European Union, which the opposition parties are using as fodder to excite the base. Britain shouldn’t leave, but they might. If they do, they’ll lose free trade with the union and the ability to move labor easily. That could be a huge issue next year. Europe is also grappling with what to do about the millions of refugees seeking asylum, crossing through Greece and Turkey. There’s a lot on Europe’s plate right not to be sure, and we think that’s what likely weighed on equities this year. Once these issues move further into the rear view mirror, there could be some wider lanes for stocks to move through.