This letter was intended to focus on 2015 but, given the results of the last two weeks, we obviously need to discuss the current environment as well. Last year was another challenging year for diversified portfolios. The bottom line is that it just didn’t provide a lot of opportunity. By our observations, all major asset classes, except U.S. Large Company Growth stocks, were down for the year. Emerging markets and energy stocks suffered the most. There were multiple issues involved for each, but the rising dollar had a negative impact on both. In fact, most all commodities and commodity producers suffered from strong supply and anticipated weaker demand along with the rising dollar. Bonds and other interest-sensitive investments were hurt by the anticipated rising interest rate environment which finally began on December 16th when the Fed raised rates for the first time since 2003.

2015 Produced Disappointing Returns Across Most Asset Classes

Asset Class

YTD % Change

U.S. Equities

1.38%

International Equities

-0.39%

Emerging Market Equities

-14.6%

U.S. Bonds

.55%

International Bonds

-6.02%

Emerging Market Bond

-11.31%

Commodities

-24.66%

Gold

-10.88

*Sources and proxies listed on the back page.

This point is not intended to be an excuse, but rather to explain that most any portfolio design that was diversified and longer-term suffered. This is difficult for all investors and advisors who embrace the historical data that this type of portfolio construction is expected to deliver better risk-adjusted returns over time.

At the beginning of 2016 we logically expected to see some selling in large-cap growth stocks, driven by investors de-risking and taking gains that would not be taxed until April, 2017. That being said, the level of selling we saw last week was surprising and went far beyond gain harvesting. US Small companies are now at their lowest value in almost 2 ½ years. So what’s behind it and does it suggest a longer term “bear” market or just another brief respite in a grinding bull market? Though many on television suggest otherwise, no one knows the answer to this question.

The selling we are currently experiencing seems to have been spurred by a combination of things. A few of these may have been the aforementioned taking of gains, another sign the crazy dictator in North Korea could become a nuclear threat, more worries about the slowdown in China along with the ineptness of their central bank and securities regulators, and the ratcheting up of hostilities between Saudi Arabia and Iran. The world is definitely a scary and complex place; it always has been. The only difference is now we hear it 24 hours a day, 7 days a week.

Even in the absence of news, good or bad, average market volatility is on the rise, driven by the proliferation of exchange traded funds (“ETF’s”) and algorithmic trading models. When adding those to the volume of negative headlines we have to ingest, sentiment swings tend to happen even more rapidly. Now, even good news has become bad news. A recent example was Friday’s better than expected unemployment report. While buoying U.S. stocks early in the day, the enthusiasm waned and the major indices all closed with declines of around one percent. This made the first week of 2016 the worst performing everfor U.S. stocks. In the aftermath of last week, we are seeing articles suggesting the 2016 could become 2008 all over again. Some of these came from TV experts that only last month were bullish on stocks. Should we really be surprised by this?

To be very clear, we do not pretend to be prognosticators nor soothsayers. However, we do quite a lot of research and we are having a difficult time finding parallels to 2008. That said, current momentum is clearly pointing downward and we could easily see further drops in prices, maybe even enough to reach bear market status (it’s been so long since we’ve had any prolonged downturn that it almost seems like one should happen). In fact, as of this writing, the average stock in the S&P 500 is down approximately 23% from its high. However beyond that, there is much evidence of positive improvement in the U.S and other economies that should counter balance much of the negatives. If the weight of the evidence is compelling, we adjust allocations and holdings accordingly.

It is moments such as these where successful investors and their advisors must rely on an objective, non-emotional assessment of facts and the overall conditions. Presently:

  1. Equity valuations in the U.S. are barely higher than long term averages, those in most international and emerging markets are at or below those averages.
  2. While generally deemed a headwind, monetary policy around the world is still very accommodative. Most economists conclude that rates in the U.S. will rise very slowly over time and many other central banks are engaged in lowering rates, quantitative easing or both. History does not show that rising rates spell ruin for stocks. In fact, markets have generally performed well after absorbing the initial increases.
  3. Inflation remains low but steady.
  4. Fuel prices are very low which generally increases consumer spending power and corporate profits for non-energy centric companies.
  5. U.S. unemployment is low and there are some signs that more workers are entering the workforce.
  6. There are strong concerns about the impact of the rising dollar on emerging markets. However, the 1998 currency crisis taught these countries how to better manage public debt and current account issues. We have seen positive year over year improvements in many.
  7. Finally, investor sentiment which is a contrarian indicator is turning more and more negative. 
     

These factors suggest to us that it makes more sense for long-term investors to sit tight and/or add to attractive positions at bargain prices. Again, we are not suggesting that we won't see further declines. Instead we believe, the overall positives, though currently more difficult to see, may outweigh the negatives.

As mentioned previously, be prepared for levels of market volatility to continue to stay very high. One and two percent swings in a day have become somewhat common. There is an old saying that goes, "In the short run, the market is a voting machine, moving up or down based on investor emotions, but in the long run it's a weighing machine, focused on the earnings of companies". We believe this will hold true in the future.

Of course, patience and discipline are concepts more easily discussed than applied. The combination of low return and heightened volatility is challenging for us all. We remember how much better we felt reviewing client statements in January, 2014. Returns overall were very favorable and some of you may have credited us with being smarter than we are. In January, 2015 and at present, the direct opposite may be occurring. We believe the truth lies somewhere in between. We are not smart enough and certainly do not want to be so arrogant to bet the bulk of your assets on any idea or conclusion we may make no matter how convicted we feel at the time.

In moments like these, two of most damaging moves for investors would be to throw in the towel and accept sub 1% certificate of deposit yields or to chase return, investing only in the areas that have done well recently. Both of these actions are symptoms of a phenomenon called “recency bias” that behavioral-finance research has shown to be very common and negative for investors long term. Data shows that recent performance, good or bad, is not a good indicator of future returns. As an example, looking back at international equity returns since 1990, there were 86 rolling 24-month periods with negative return. The average annual return in the subsequent 24-month periods was 12.56%. While this doesn’t guarantee that next year’s returns will be higher than this year’s, it does highlight that investment returns are neither consistent nor earned evenly over time. We see helping our clients understand these concepts, avoid emotional tendencies, and maintain discipline as being some of the most important aspects of our role as their advisor.

In closing, we want to reiterate that the past two years have not been typical. With the way the press works, this hasn’t been easy for investors to appreciate and has been especially challenging for us as advisors. Large company stocks do not consistently outperform small company stocks, growth stocks do not consistently outperform value stocks, dollar rallies do not continue indefinitely, and emerging market stocks do not consistently underperform U.S. stocks. For these reasons and others, we will continue to practice asset and strategy diversification, cautiously allocate money to what we believe are undervalued areas, and diligently monitor what we own. To help us in these efforts we have added some bright individuals to our team. We expect to add more in the upcoming months as well as make additional improvements that we feel will greatly enhance our capabilities and service to our clients. We are grateful and humbled by your trust and confidence and will continue to work diligently to honor both.

As always, thank you for allowing us to work with you.

The CCA Investment Team

1 - Sources and Proxies: Sources Zephyr and Factset. Data as of December 31, 2015. U.S. Equities = S&P 500 Index, International Equities=MSCI EAFE Index. Emerging Market Equities=MSCI EM Index. U.S. Bonds=Barclays Capital Aggregate Index. International Bonds=Barclays Capital Global Aggregate ex-U.S .Index, Emerging Bonds=Barclays EM Local Currency Broad TR USD Index. Commodities=Bloomberg Commodity Index. Gold=S&P GSCI Gold Index..

Investing involves risk including the potential loss of principal. No investment strategy can guarantee a profit or protect against loss in periods of declining values. Past performance is no guarantee of future results. Please note that individual situations can vary. Therefore, the information presented here should only be relied upon when coordinated with individual professional advice.

These Blogs are provided for informational purposes only and should not be construed as investment advice. Any opinions or forecasts contained herein reflect the subjective judgments and assumptions of the authors only and do not necessarily reflect the views of FSC Securities Corporation. There can be no assurance that developments will transpire as forecasted and actual results will be different. Data and analysis do not represent the actual or expected future performance of any investment product. We believe the information, including that obtained from outside sources, to be correct, but we cannot guarantee its accuracy. The information is subject to change at any time without notice. Indexes are unmanaged and do not incur fees. It is not possible to invest directly in an index. Standard & Poor's (S&P 500®) Index is a market capitalization-weighted Index of 500 common stocks chosen for market size, liquidity, and industry group representation to measure broad US equity performance. S&P 500® is a registered service mark of McGraw-Hill Companies, Inc..