Thanksgiving weekend sort of marks the beginning of the end of the year for me. It acts like an intersection where we look both ways before stepping forward. For this update, we'll look backwards at the challenges of 2015 and forward toward the developing landscape for 2016.
2015 - A Tough Year For Everyone
Actually, I'm going to say with clarity that 2015 will go down as the hardest year of managing money in my 22 year career. I'm going to complain for a moment but it will tell a story that you might not be aware of. If we back up the tape, we had/have geopolitical turmoil (Russia, ISIS, Greece), we have had global and sector level devastating bear markets (China, Energy, All Commodities, High Yield Bonds, Metals and Mining, Brazil and Emerging markets), blow ups in bell weather stocks like Walmart, Qualcomm and Caterpillar, Inc. We weathered through trendless equity markets (S&P 500 crossing above and below the 2100 level 40 times now?) and subsequent flash crashes of 13% (US Markets in late August). We have seen corporate earnings beat very low estimates but continue to get marginally weaker in absolute terms each quarter (Q3 aggregate corporate revenue growth was the lowest since 2009). Monetary policy has flipped three times by my count; between policies of support and easing rates to expansion angling to raise rates. The US dollar ripped strongly higher into May only to correct sharply through September, and now back out again to a new 4 year high. And in early November, I made a note in my investment journal in all caps - ALL ASSET CLASSES NOW DOWN YTD (bonds, stocks and commodities). Of course, things like a global pandemic (Ebola) reaching US soil created some issues as well. Real estate seems to be a bright spot along with continuing strength in employment, higher savings rates, and low inflation and yet there seems to be very little consumer demand in the system or certainly a willingness to invest in anything (individuals or corporate). Black Friday is a bust, no one shopping. Wow, what a year.
As trend followers, you might begin to understand the difficulty in finding good homes for investment capital that last more than a few days - or hours. Yes, I'm bitching and whining. We're exhausted and tired of trading with nothing positive to show for it. Virtually all of our investment strategies are down on the year, a little, but strangely I'm thankful that we didn't we have any blow ups at the same time. "Would have" or "should have" voices dominate my thoughts daily but I know this is just the nature of the beast. We've been here before. We follow our system which is built to allocate money appropriately and dynamically using sound design, controls and features. But it doesn't guarantee perfect results. We're not happy but we accept that some years are just tough for our style of management.
In October of 2014, at our annual client meeting, I stated clearly that we were entering a transition period for the financial markets. After six years of economic recovery from the great recession, the system was clearly ready to wean itself off of Federal Reserve life support and a zero interest rate policy. This was easy to see from a market perspective and we have played this well by holding positions that benefit from a rising US dollar, including investments in the US Dollar itself. What was less clear was the emergence of all the other stuff listed above. Just coincidence? Sympathetic events? But here's the good news; we're getting through it. 2016 is not going to be like 2015.
2016 - New Opportunities
I see more opportunities to make solid investment returns in 2016. I can't say with any confidence what the broad market stock indices will do. We could see our current correction turn into a full blown bear market on the back of weak global demand and new signs of global recession or we could see the Dow at 20,000 by Labor Day. I can easily make a case for either scenario along with the hoards of market gurus pointing in exactly opposite directions. Historical precedent, seasonality, cycle work, technical and fundamental evidence are all conflicted. Passive indexing might be a (lucky) winner again like 2015, or it could be a source of great anxiety. We're not willing to hold and hope for any specific outcome at this point. The chances of a real global bear market look higher closer to the end of the year in our view and that would be the case only AFTER the Federal Reserve has raised rates 3-4 times. Unfortunately, that is a consensus view and the market loves a good surprise. We need to remember that bear markets are cleansing events that wash away excess, reset value and offer investors real return opportunities; something we haven't seen since 2009/10. If the broad market wants to blast higher, with classic late stage multiple expansion and stronger participation from multiple sectors and asset styles (not just Amazon and Netflix) that too presents return opportunities. These could come early in the year.
From a value perspective, there are plenty of options. The problem is that the best values continue to lose ground every week now. We will remain patient. Some of the very best value managers of mutual funds with brilliant long term track records are down double digits this year, some making new lows even last week. These are funds like Longleaf Partners, RS Partners, Heartland Value, Aegis Value, Third Ave Value and yes Berkshire Hathaway! When the broad US capitalization weighted stock indices like the S&P 500 finally buckle, we'll be checking in daily with our value favorites. My guess is that they will suddenly begin to rise and never turn back having accumulated all the shares of the stuff that everyone hates now (energy, materials, metals, industrials, emerging markets, China, India). We are already finding attractive entry points for individual companies, now considered value plays, for our all stock strategies. At some point soon, we'll also be able to pick up some best of class value ETFs and mutual funds for our Blended Asset strategies as well. These present enormous return opportunities.
I also see a developing opportunity in High Yield corporate bonds for all of our Income strategies. This asset class is very likely in a bubble and may have begun the process of bursting. High yield corporate bonds are already in a downward spiral and we have exited all positions across all strategies. Default rates are on the rise among energy and consumer discretionary issues and we have seen far too much late money chasing yields with false assumption surrounding the inherent risks. If the Federal Reserve embarks on a period of higher interest rates, High Yield will subsequently get smashed. We saw this happen in the year 2000 and 2008 associated with the collapse of global stocks; again after a short period of tightening by the Fed. Again, bear markets in any asset class create opportunities. The best and strongest returns for our Income models have both come in the years following deep sell offs in High Yield bonds. I am optimistic for these programs in the later half of 2016 and beyond and will be loud about recommending them to our clients when the time comes.
While 2015 was a just a messy year of chaos and disorder, we see 2016 as year of resolution with more clarity. Clarity does not have to mean rising prices but rather clearer trends with fewer unknowns. Last week, in my regular client reviews, I had several conversations about performance in the past year and what we expect looking forward. We haven't made money so far in 2015 and that's always a disappointment but all strategies are still within short striking distance (3-5%) of all-time highs. Given the opportunities, deep value discounts and larger risks I see in the market, I think the results of all risk managers or others committed to trend following or dynamic asset allocation will be profoundly better on a relative basis looking forward. Our least attractive moment is in the late stages of every bull market (now) to be followed by our most attractive moments as the market finds resolution (next). If I have a concise message to all clients in here, it would be this; Stay patient and you will be pleasantly surprised.
I hope everyone has a happy and carefree holiday season surrounded by your most important assets - friends, family and personal health.