By David Nelson, CFA
Let’s take a quick trip down memory lane before looking ahead to this year. 2015 was frustrating for both Bulls & Bears with the S&P and Dow unable to breakout convincingly in either direction. Only the Tech heavy NASDAQ managed a positive return on a price basis. Here in the U.S. the Russell brought up the rear down over (-4%) while the S&P came in just below the flat line (-0.73%). Add the dividend and the SPX goes green.
On the last trading day of the year I joined CNBC’s Closing Bell hosted by Bill Griffith and Sara Eisen. Also on set was Mike Santoli who accurately pointed out that if the SPX had closed positive for 2015 it would have miss-represented the performance of the average stock. With more than 20% of S&P 500 stocks in bear market territory that message rings true. Earnings were just about flat for the year so all in the index performance makes sense.
Predictions
I’m not making any. Group think seems to point to a year that looks a lot like the last one so expect something we haven’t seen yet to throw everyone’s game plan for a loop forcing fund managers to call an audible at the line of scrimmage. The danger with predictions is that we tend to extrapolate recent trends forward. A better tool might be to look at the Assets and Liabilities making up the market balance sheet.
Assets
Jobs – Any discussion of jobs raises the political rhetoric from both sides of the aisle. The left likes to point to the over 60 months of non-farm payroll growth while the right focuses on the labor participation rate sitting at a near decade low of 62.5. Like most things in life the truth probably lies somewhere in the middle. The chart below is a comparison of Job Openings to Continuing Claims. December openings came in at 5.4 Million vs continuing claims at 2.2 Million. If the trend continues it could be good news for investors.
Oil – Oil has been a blessing and a curse with some like myself calling it a potential Black Swan. Nevertheless consumers benefit each time they pull up to the pump. The health of the consumer is probably better than we think. Spending is likely moving from the cash registers at the mall to online giants like Amazon (AMZN).
EPS Growth – Current estimates for the S&P 500 sit just shy of $128 for 2016 which implies about 7% growth year on year. That’s good news following 2015’s anemic financially engineered returns driven by wave after wave of buybacks.
Unfortunately CEO’s continue to pick the low hanging fruit but at some point the game runs its course and you’re forced to re-invest. Current estimates include more of the same but for now I’m keeping earnings growth on the asset side of the balance sheet.
Sector Returns – Not all sectors are struggling. The challenges in the energy complex are well known but other sectors like Tech, Healthcare and some parts of Consumer Cyclicals still exhibit secular growth. FANG stocks (Facebook (FB), Amazon (AMZN), Netflix (NFLX) and Google (GOOGL) drove most of last year’s returns but has become a very crowded trade.
Admittedly the noise surrounding healthcare is going to get nasty as we head into an election year. Biotech’s with high priced drugs like Gilead’s (GILD) $1000 pill are an easy target for candidates but lifesaving treatments end up being far cheaper in the long run.
Rates are Still Low – It’s true that the Fed has launched but the terminal rate will be much lower than previous cycles. Those stretching for yield in MLP’s and Junk are re-thinking that strategy and might return to good old fashioned stocks offering total return.
Liabilities
Oil – Like I said earlier oil has been a blessing and a curse so it’s important to look at the dark side as well. Sixteen percent of the junk bond market is energy stocks with some concerns like Chesapeake (CHK) seeing their debt trade at 25 cents on the dollar. We’re seeing the first wave of defaults so it shouldn’t be surprising that some bank CEO’s like Bank of America’s (BAC) Brian Moynihan are concerned about the credit profiles of their consumers living in energy producing states. It’s already hitting state budgets of some like Alaska where they are considering their first income tax in 35 years.
Increased tensions in Middle East could cause a spike in crude but sustained higher prices will have to be accompanied by a better supply/demand backdrop.
Dollar – The U.S. Dollar is up over 25% in the last 18 months. It’s been confined to a range since peaking in early March but could breakout to the upside given the divergent path of world central banks with current Fed policy. Industrials took it on the chin last year. It was rare to be on a conference call without management pointing to the revenue headwinds coming from a strong dollar.
The Fed – While I expect the terminal funds rate to be lower than previous cycles rising rates puts pressure on multiples. With little chance of multiple expansion the market is probably capped by earnings growth.
China – Weakness in the world’s second largest economy has triggered several sell-offs forcing President Xi’s administration to step in and support the market. The worldwide decline in commodities and oil is in part the result of a slowdown in their manufacturing sector and excesses in their financial system.
Geo-political Chaos – One look around the world would give any investor pause. As I’m writing, headlines are coming across the tape saying Saudi Arabia has severed diplomatic relations with Iran. ISIS continues to dominate the news here in the states with polls showing that terrorism tops the list of voter concerns.
Add a little insurance to your portfolio. Defense stocks tend to do well post a terror attack and most candidates running in 2016 support increased military spending.
Self-Indulgent CEO’s – I’ve been a longtime critic of CEO’s who fail to live up to their responsibilities to shareholders and with each year that passes the problem seems to get worse. The continued use of buybacks to shore up earnings at the expense of R&D and CAPEX seems to be the first choice of Fortune 500 CEO’s. Why invest in a new factory or hire new employees when another round of buybacks will goose the earnings sooner helping management meet stock based compensation goals.
Kicking off the year
Obviously there are a lot more factors at play but the above are some of the key themes likely to drive investor returns. Everyone will be looking at January performance as an indication of what 2016 has in store for U.S. investors. The January indicator is one of those metrics that works right up until the time I use it. My advice is to build your portfolio one stock at a time. The bull market is long in the tooth and the tide isn’t going to lift all boats. Look beyond the headline numbers and focus on those with real top and bottom-line growth that aren’t totally dependent on buybacks or other financial engineering gimmicks.
