The good and the not-so-good

Stocks finished November only slightly higher, for a year-to-date return of 3.01% as measured by the S&P 500. November’s gains were somewhat unimpressive after a snappy 8% rebound in October. Just the same, a plus sign is a plus sign and often directionality is more important than degree of change. The year has not been an easy one for stock investors, without much energy or continuity.

As is often the case, not all stocks behaved the same. For example, growth stocks generated much better returns than value stocks. Returns to large capitalization stocks exceeded smaller stocks. Interestingly, dividend paying stocks performed poorly all year long. Investors were mistakenly drawn in by the low rate environment. The market chose to reward stocks with attractive growth prospects as evidenced by the +10% year to date return of the Nasdaq 100 (QQQs) index.

The best sector thus far has been consumer discretionary (stocks like Amazon.com, Starbucks, O’Reilly Automotive), with returns +11%. The health care and technology stocks also exhibit strong growth characteristics and fared well. In stark contrast, the worst sector was energy, with returns -14%.

A complicating factor this year was the poor performance from other asset classes typically used to offset risk or diversify the behavior of stocks. For example most categories of fixed income produced negative returns for the year (with the exception of short and medium term US Treasuries). Other popular asset classes such as commodities (DBC) -23%, Gold (GLD) -10%, emerging markets (EEM) -13%, MLP’s (AMX) -30% and REIT’s (VNQ) .6% did nothing to offset a subpar year in US stocks as they often do.

For some context, 2015 is following two successive years where the asset classes we utilize worked collectively to produce attractive and above average returns. In the shadow of the recent past, this has been an underwhelming year. The logical question comes to mind, what lies in store for 2016?

The answer is not entirely clear. Most importantly, earnings forecasts for the S&P 500 for 2016 are @ $130 per share. From the market’s month end 2,080 close, this equates to a forward P/E ratio of 16x. Not a bargain, but certainly not over-priced. There are a multitude of things that can, and will effect corporate earnings as we move through the year, and we will modify our view, and expectations accordingly.

A few of the good things to keep in mind include the stock market’s behavior since the August/September sell down.  Much of the recent economic data has been positive, particularly GDP, job creation and housing numbers. Analysts are projecting 2016 earnings growth of 8% and revenue growth of 4% (FactSet Research). The Federal Reserve will likely raise rates at its December meeting putting the Fed Funds rate in line with the markets’ expectations and possibly providing more favorable spreads to the financial stocks.

A few of the not-so-good things to bear in mind include increasingly weak market breadth (number of stocks going up less than the number going down). The geopolitical backdrop is discomforting. Terrorism is seeping out of the Middle East (Paris, San Bernardino). The oil surplus continues to raise havoc. I think the oil markets will take longer to resolve than most expect. The strong US $ is leading to earnings issues for US corporations choosing to repatriate foreign earnings. Finally, US fiscal policy needs to come alive and help stimulate sustainable economic growth.

As is always the case, the backdrop is a hodgepodge of considerations. The wall of worry is there. With that backdrop, I think earnings (and thus stock prices), will show improvement in 2016. This will require some hard to find revenue growth. I also expect many of the other asset classes that floundered this year to rebound in 2016. Finally, fixed income remains important to our portfolios (municipals look attractive) though I expect muted returns.

We are finalizing tax loss selling in an effort to limit capital gains. We did take profits in several stocks that rose impressively in value over the last few years. Please feel free to reach out if we have not talked about this and you would like to review. Thank you for a wonderful year. We wish you a peaceful holiday and a prosperous new year!    

Bruce Hotaling, CFA

Managing Partner

The views and opinions stated herein are those of Bruce Hotaling, are of this date, and are subject to change without notice.   Information contained in this report was received from sources believed to be reliable, but accuracy is not guaranteed.  Investments are subject to market risk, including the possibility of loss of principal.  Past performance does not guarantee future results.  The S & P500 is an unmanaged index of 500 widely held stocks.    Investors cannot invest directly in an index.   The PE ratio (price/earnings) is a common measure of relative stock valuation.

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