Six for '16

Investment Commentary

With increased market volatility, 2016 is proving to be an interesting year. To help you make sense of the markets, I want to share key themes for 2016.

  1. Global / U.S. Growth - The world's absolute level of growth is and has been slowing - that's an unfortunate fact. The extent, to which it re-accelerates, where and when, is the $64,000 question. Unfortunately it is likely that it will take many, many quarters for global growth to re-accelerate back to any semblance of its long-term trend growth rate - and as some have forecast, that may never happen.

    We don't share that view. We believe that global growth will re-accelerate, but we may just find a new secular trend growth that's slightly less than the past. Think of 2016 as "A Tale of Two Halves." We believe that the stubbornly slow global growth picture and the strong U.S. dollar will continue to take a bite out of U.S. and global growth into the first and second quarter. As the dollar slows in its assent vs. developed and developing currencies, and global growth stabilizes from monetary and fiscal policy actions from foreign central banks, we believe growth will accelerate in the second half.

    Our global growth target for 2016 is 3.1% vs. the International Monetary Fund (IMF) forecast of 3.4%.1 We estimate that U.S. real GDP for 2016 will be 2.0% vs. the consensus estimate of 2.4%.2

  2. (U.S.) Interest Rates - On December 16, 2015, the Federal Open Market Committee -"The Fed"-unanimously voted to set the new target range for the federal funds rate at 0.25% to 0.5%, up from zero to 0.25%. Policy makers separately forecast an appropriate rate of 1.375% at the end of 2016, implying four quarter-point increases in the target range this year. The Fed stated that they will continue to be "data dependent" and will be watching international developments closely.

    Given our U.S. real GDP views above, the magnitude and velocity of recent economic data and current market volatility, we do not believe that the Fed moves 4 times-nor will the rate be 1.375%. Our baseline view is that the Fed moves 1-2 times, with a year-end target of 0.625% to 0.875%. If the Fed honors their "data dependent" statement and markets continue to act as they currently are acting, we believe that there exists a high potential of no interest rate hikes at all in 2016.

  3. (U.S.) Inflation - For much of the last 4½ years, inflation both here and abroad, has been stubbornly low. Massive monetary and fiscal policy stimulus globally has fought hard to kick-start growth and reflate asset prices. Weakening global demand and suppressed commodity prices have contributed to lower rates of inflation; rates well below the U.S. Fed's comfort level of 2%.

    Our view is that continued weakness in commodity prices, slowing global demand and lower productivity growth continue to put downward pressure on inflation and keep inflation levels significantly below the Fed's 2% desired threshold throughout much of 2016. Stabilization in global growth in the second half of 2016 will help, but not enough to get us anywhere near the Fed's comfort level.

  4. The Strong U.S. Dollar - The U.S .dollar (USD) had shown remarkable strength throughout 2015 on a relative trade basis to both the developed international currency basket as well as the emerging currency basket. Continued foreign central bank quantitative easing will put downward pressure on the Euro and Yen, as well as many emerging market currencies (especially emerging Latin America). And while historically a hike in U.S. rates has led to temporary U.S. dollar depreciation, this time around, it might be different given the scope and magnitude of foreign central bank policies around the world.

    Our belief is that the dollar remains strong relative to both a developed and developing currency basket in 2016, though the velocity and magnitude of that strength significantly subsides in the second half of the year, and is much lower in absolute terms relative to 2015.

  5. Commodities - They say that one's eyes are the window to the soul. Well, commodities are the window to global growth. As goes expectations for global growth, as goes commodities. A slowdown in real growth from the largest economy in the world - China3 - has triggered a broad-based selloff in global commodities. Broad commodities (as represented by the Bloomberg Commodity Index) started its initial decent all the way back on April 29, 2014. Since then, commodities have plunged over 41%. U.S. Oil (WTI) began its descent a few months later in July 2014. From that point through February 10, 2016, WTI is down over a whopping 70%. Decreased demand, massive oversupply, high levels of continued output from OPEC nations and a strong USD, coupled with a slowdown in global growth has gotten us to where we are now.

    Similar to our views of global and U.S. real growth, we believe that commodities continue to weaken through the first half of 2016 as the overhang from slower growth / reduced demand, oversupply, and a stronger USD play out. As global growth and broad aggregate demand begins to stabilize and the strength in USD abates, we believe that broad commodities and oil start to find a bottom in the second half of 2016.

  6. (Global market performance in 2016) Dichotomy between broad macro/micro economic events and market performance - Markets are expectational pricing mechanisms - i.e. they bid themselves up or down in anticipation of what is likely to come, not necessarily on what has already transpired. Markets have bid themselves up for 6¾ years in anticipation of an economic recovery that has yet to truly manifest itself. We may likely see distortions in asset prices that are not intuitive and potentially irrational.

    We have already seen significant signs of that in 2015 (as well as 2011-2014!) - good news is sometimes good news, and sometimes good news is bad news, and vice versa! This crazy dichotomy makes it very challenging (and potentially deadly) to try to time markets. Remember - it's time IN the market, not timing the market that creates long term wealth! Having said that:

    We believe that the first half of this year is likely to see significant pressures from a continued:

    • Overhang from a stronger USD in 2015 into 2016 and its effect on corporate earnings and profits,
    • Slowdown in global growth (both real and perceived),
    • Pressure on commodity prices.
    • The potential for a 10% - 15% market correction is in place.

    We believe that the second half of this year is likely to see a significant reversal in sentiment and market performance as US dollar headwinds fade, global growth begins to stabilize, and commodities look to find a bottom. Look for a potential recovery in the second half, ending this wild rollercoaster at or slightly below zero.

I want to make a couple of other quick key points:

Number One - Panicking is not an investment strategy - it's a guaranteed recipe for disaster, so no matter what happens in the markets from here - don't panic - it will most certainly lead to asset impairment.

Number Two - Taking a "time out", moving to all cash, and sitting on the sidelines is more often than not, a sure-fire way to make sure you never accomplish your financial goals - Especially when cash today has a guaranteed negative real rate of return.

Summing it all up:

Since the Great Recession of 2007-2009, in an effort to breathe life back into the consumer, corporations, and the broad global economy, the Fed and other foreign central banks engaged in a massive simulative campaign called quantitative easing (sometimes described as "accommodative monetary policy").

In response to this attempt at economic resuscitation, the markets bid up stocks and other risky assets in anticipation of a global economic recovery that has yet to truly manifest itself. When the speed and magnitude of the recovery didn't live up to (lofty) expectations the market had placed on that recovery, the market simply has re-priced itself lower and that, in a nutshell, is where we find ourselves today.

So this is not some cataclysmic meltdown, no meteors into the planet, killing dinosaurs-like event - this is simply a market re-pricing itself to adjust to the true speed of this global economic recovery.

Over the next several weeks and months we will have A LOT more clarity around the true global growth picture, and the nature and extent to which this slowdown or lack of global growth truly effects both the consumer and corporations. Stay tuned....

Dalbar and Associates and Morningstar4 did a study in June 2015 on 20-year returns of asset classes and portfolios, and what the "average investor" receives in returns vs. the market and other diversified portfolios. From 1995-2014, a generic 60/40 portfolio of U.S. stocks and bonds returned an average of 8.7% per year for 20 years. The "average investor" because of behavioral market timing returned only 2.5% - barely more than a quarter of that portfolio's returns.


1IMF estimate, World Economic Update, January 19, 2016.

2The Conference Board December 9, 2015 Consensus - Estimate

3IMF World Economic Outlook: IMF World Economic Outlook (WEO), October 2015 - as of October 31, 2015, China is the world's largest economy on a relative purchasing power parity basis

4Dalbar Associates, Quantitative Analysis of Investor Behavior 2015