From 2011 to 2014, the US stock market reflected the economic recovery that followed the recession of 2008/2009. Hindsight is always a lot clearer than forecasting, and those years are sometimes remembered as a smooth return to US economic stability. What isn’t so clear in our memory is the role monetary policy and low interest rates had in helping the markets regain confidence.
For most of 2015 there has been an ongoing debate about the future direction of interest rates. For those who do not follow these things day to day, US interest rates have been abnormally low for several years as the Federal Reserve Bank used the tools available to it to help foster the economic recovery. Low interest rates, or “cheap money” was one of the tools used, moving rates gradually to almost zero. In the case of interest rates, a return to normal would mean that lenders would get a reasonable return on money lent to governments, businesses, and individuals. Lending involves a degree of risk that reflected in both credit, the borrower’s likelihood of repayment, and time. A zero percent interest rate is not normal and does not reward lenders with a return.
This cheap money strategy has been successful in guiding the US recovery and encouraging a stronger stock market, increased company productivity and profitability, and increased employment. The current US unemployment rate of 5% is considered by most economists to be near “full-employment” and inflation, the measure of price increases on goods and services, is moving higher. Perhaps it’s time to return to normal monetary policy.
The US stock market suffered a correction in September and October when the Federal Reserve indicated that an expected nominal hike in interest rates might be postponed. The Fed announcement that rates would remain near zero caused confusion as investors questioned the Fed’s view of the future. This unexpected hiccup made everyone doubt the recovery and the stock market corrected down.
On Dec. 29, 2014 the S&P 500 closed at 2090. Today, almost 11 months later, the market is still at 2090. Bond prices, which reflect interest rates, have also been flat for the last year, real estate has been mixed, and commodities, including oil, have declined throughout the year. The personality of the financial markets has changed, and it took the collective investor community most of 2015 to realize this.
Investors are looking for the next signal, and want to know if it is safe to come out of their fear. Recent weeks have helped dispel some of the doubts, and it now seems that the Fed’s path forward will include a slow, gradual series of interest rate increases that will help return the economy to a more familiar interest rate condition. We believe there will be a small interest rate increase in December; the beginning of a process the media is calling LIFTOFF.
Europe’s recovery is lagging behind the US. Europe needs help and the Central Bank is providing lower rates and policies similar to those that worked in the US. Greece has successfully found it’s way through their crisis which caused so many headlines and now appear to be working with their creditors to re-establish trust. Asia is still lagging, largely due to the shadow cast on the region by China’s slowed growth and the market’s reassessment of China’s economy going forward. China remains a huge labor pool, consumer of raw materials, and exporter. The impact of China on the Pacific region and the rest of the world will continue to be significant. The current growth estimates for China’s economy are over 3X that of the US, so concerns about a slowed economy should be understood in relative terms.
Where do we go from here? There are some measures that suggest that the rest of the World (ex-US) may be in or entering recession. This is not true of the US, where all signals suggest we are continuing with sustainable growth, although the expected cycle between peaks and valleys of prosperity is already longer than average. We should expect to see the US economy and markets begin to roll over in the next year or two. Some segments will continue to show returns for many months and opportunities will emerge as sectors rotate in this new environment. For example, in recent months we have seen major restructuring in both media and retailing as investors have tried to understand the impact of technology on those industries. Large media content and delivery firms like Disney, Universal, Comcast, Verizon have been challenged by “disrupters” like Netflix and Facebook, along with consumer’s desire for media unbundling. There has been a shift in investor’s perceptions of the shape of the future. Similarly, traditional retailing giants like Macy’s and Walmart continue to be threatened by internet retailers like Amazon, E-Bay, and others who are seeking to understand consumers in an internet age where shopper’s priorities are different and shopping habits are still evolving.
We believe that this is not the time to take all the chips off the table and hide. Now is a time to pursue proven sectors, watch for bottoming in beaten-down areas, and to use and respect capital protection. It is OK to not be fully invested and it is OK to avoid areas where fundamentals will change. It’s also OK to find clear trends and invest, there are good things happening in the world.
Most importantly, we remember that investment returns average 6% over the long term. The last few year’s double-digit returns have been extraordinary, and now is a time to patiently prepare for when those opportunities will come again. As investors, we need to take a long view, understand some years will be better than others, and focus on protecting our client’s capital.
We protect every investment position with a stop loss to retain profits and exit positions that lose value. In an up market, this risk protection is virtually free. In a down market, this protection is priceless, exiting the market before the damage is too great. In a transitional market, where there is no real trend and prices move up and down, we accept small losses rather than further exposing the portfolio to more damage. These transitional markets are those where risk is highest and protection is most needed.
At Calyx, we help families with accumulated assets protect and manage their financial resources. We are a financial advisor and investment manager that partners with our clients to administer their financial affairs with personal attention and active management. We provide the only individual account conservative family portfolio management program of which we are aware available to retail investors that includes true investment protection, low fees and a track record of delivering returns.
Our Second Opinion Service is a free review of a family’s financial situation and portfolio. Our clients have told us that the information has been surprising and useful.
This service is available for our clients to make to their friends, family or others around them who are unsure about their money. We are also making this service available to readers of this Quarterly Comment and their friends and family.
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