HERE COMES THE NEW YEAR!

In writing this letter each week, I try to be a translator, coach and disparager of inaccurate conclusions for you by attempting to help you navigate the confusing daily mass of information around the markets, economy and managing your investments.

In this issue, I want to touch on the year past, along with some thoughts to help you transition into 2016.

THE 2015 MARKET

During every secular bull market, there are years where stocks take a rest and 2015 appears to have done just that. This year was dominated by the worst thing the markets have to deal with – uncertainty – so it’s not a surprise.

One source of the uncertainty, i.e., when and by how much the Federal Reserve would begin raising US interest rates, has been resolved. The other, settled global oil prices, has yet to be determined by the markets.

In terms of where this year has brought us so far, both the S&P 500 and the Dow Jones Industrial Index are down more than 2.5 percent for 2015, while the NASDAQ composite is up about 4 percent. No big deal…no trends broken or begun.

The Dow transports traded down to hit a new 52-week low. And, in intraday trade last week, the index was briefly off more than 20 percent from its all-time intraday high hit in November 2014. This doesn’t seem to logic out when low oil has such an important effect on the companies involved.

Gold is off about 11% for the year and the US crude price traded near its lowest level in 7 years at around $34 per barrel – just about 18 months after hitting $107… Those prices, along with those of other major commodities, have combined to move the Commodity Research Bureau (CRB) Index to its lowest level since mid-1973! A strong US dollar and slow global growth have contributed to those lower values as well.

If nothing else, I think these commodity data definitely show the innate cyclicality of all the markets. Please don’t assume that what was the result this year will continue through the next one…whether for commodities, stocks or bonds.

OIL

The focus on oil prices continues. I think it’s mostly psychological as the price isn’t really a good economic indicator. The price reflects both demand (which has been pretty good) and supply (which has been more than currently needed). Nonetheless, the energy sector continues to lead the entire stock market, including many stocks that are obviously not directly related. I think it’s worth adding that oil prices are down because of new supply, not a “potential” set of rate hikes “sometime in the future.”

Energy and materials account for more than half of the cost base for car manufacturers, food producers, chemicals plants and smelters, according to a 2014 Dutch study. The first two sectors, with their less commoditized products sold to consumers, rather than businesses, seem best placed to benefit.

And, it’s good news for airlines too as fuel will account for about 21 percent of carriers’ costs next year, down from 32 percent in 2014, according to the International Air Transport Association. On one hand, IATA said profits to upstream oil companies from selling jet fuel will decline by $10 billion this year, while net income for airlines will be about $16 billion higher.

The good news for consumers, according to AAA, is that cheaper gas prices have saved Americans more than $115 billion so far this year, or more than $550 per driver. You can see that reflected in a key gauge of US consumer spending – November retail sales – which rose solidly. Since consumer spending accounts for more than two-thirds of our economic activity, the overall benefit seems quite positive.

Additionally, last week’s end by Congress of the 40-year-old ban on crude oil exports should have little immediate impact on the US oil industry. Longer term, it’s likely to help our shale producers and give the United States more clout in the competitive global energy arena. And, while new oil exports likely won’t amount to much immediately, they could provide another challenge to already fractured OPEC. (A real shame…)

JANET AND THE FED

Seven years to the day after the Fed cut interest rates to zero, Fed Chair Janet Yellen and the Federal Open Market Committee (FOMC) initiated the first hike to the fed-funds target rate since June 29, 2006. The FOMC last Wednesday approved a quarter-point increase in its target funds rate. The new target will go from 0 percent to 0.25 percent, to 0.25 percent to 0.5 percent.

After announcing the raise, Fed Chair Yellen re-emphasized that economic data remain the most important signpost for the path of future hiking. She added that, “It’s important not to over-blow the significance of this first move. It is only 25 basis points (one quarter of one percent). If monetary policy remains accommodative, we have indicated that we will be watching what happens very carefully in the economy.” Amen, Miz Y!

Yet, despite dealing with the most communicative Federal Reserve in seemingly ever, one that signals its every thought and concern, uncertainty somehow continues to creep into investors’ minds. We witnessed this same type market volatility occurring between 2012-2014. That was when Ben Bernanke and the FOMC decided to phase out the $4.5 trillion quantitative easing (QE) bond buying program, creating the so-called “taper tantrum.” Today’s market turmoil is nothing more than the equivalent of that emotional upheaval. In the end, tapering happened, the economy kept growing and the stock market moved to new highs. Seems to me that the same will be true for this rate hike as well.

Here’s why I say that.

Investors and traders alike seem to have little to no memory of market responses to rising rates. And, for whatever reason, the ghost of 2008 continues to influence many analysts, journalists, money managers and policy-makers, who still don’t seem to really understand what happened.

In any regard, S&P’s data reveal that, initially, there’s been a modest negative reaction (approximately -7% decline in stock prices) and then a significant positive reaction (about +21%). Further, a CNBC analysis of six rate-hike cycles over the last three decades shows that rising rates were often accompanied by falling unemployment, rising stock prices and solid economic growth.

To borrow from hockey, that’s a pretty nice hat trick…

MARKET THOUGHTS FOR 2016

To begin, based on my long experience in this business, I pay little to no attention to any forecast for “what the markets will do” in the year ahead. Stocks and bonds are relatively long-term instruments. When viewed through this lens it becomes clear that an investor evaluating their portfolio of long-term instruments on a 12 month basis makes very little sense.

The data are simply too random. As we extend our time periods, the data become increasingly reliable – and with a positive skew. But it still remains very imprecise, so to say. I’ve never seen an actual annual return equal the long-term average numbers of the various indices.

The bottom line is if you’re going to hold stocks and bonds, it’s almost certainly best to plan on having at least a 3-5 year time horizon. Any analysis and prediction less than this is likely to resemble gambling. And investing is not intended to be a gamble.

S&P’s folks report that at almost 82 months, the advance in the Standard & Poor’s 500 Index that has lifted share prices by three times is set to become the second-longest ever next year. This eclipses a time period in the 1950s in which prices almost quadrupled. So, simply because it’s gone on for a while, some investors wonder if that length of time can becomes a barrier to further progress. Janet Yellen even touched on that at her post-raise news conference. She said, “It’s a myth that expansions die of old age and that a recovery’s days are not necessarily numbered.”

Adding to that thought, Jeff Rubin, the director of research at Birinyi Associates Inc., says “bailing out just because prices have been going up is a standard error of market timing that will usually end up losing money. Just because the market is some number of months old doesn’t mean it can’t become twice as old. It just doesn’t work like that. Just as the economic recession was unprecedented, it’s possible we’re in an unprecedented and long expansion as well.” Yes, it is, indeed.

CONCLUSION

Sir John Templeton coined the phrase, “Bull markets are born on pessimism, grow on skepticism, mature on optimism and die on euphoria.” I don’t see any market anywhere close to euphoria – investors in general are only now starting to be optimistic.

For the coming year, consider this. Since 1930, about 67 percent of years have been positive for the S&P 500. More specifically, after a year in which the index falls, the odds it will rise in the next one are 63 percent in favor, data compiled by Bloomberg show. Odds that one up year will be followed by another are 66 percent.

Growth has been, and will continue to be, powered by new technology and entrepreneurial spirit, not Fed policy and certainly not Congressional/administration blatherings.

No letter next week so please have a very Merry Christmas, a belated Happy Hanukah and, for sure, a most happy, healthy and way prosperous New Year!

See you in ’16!

Cheers!

Mike

Securities and Investment Advisory Services offered through KMS Financial Services, Inc.

To get an overview of economic conditions, use this link. It’s updated monthly. http://www.russell.com/Helping-Advisors/Markets/EconomicIndicatorsDashboard.aspx

Past performance is not indicative of future returns.

Investing in securities of any type involves certain risks, including potential loss of principal. Investment return and principal value in a bond and/or securities portfolio will fluctuate so that investments, when sold or redeemed, may be worth more, or less, than the original investment.

Investing in sectors may involve a greater degree of risk than investments with broader diversification. International investments are subject to additional risks such as currency fluctuations, political instability and the potential for illiquid markets. Investing in emerging markets can accentuate these risks.