It didn't take long for the stock market to make a mark on the New Year, kicking things off today with a 2% loss. Expect market commenters to deluge us in the days ahead with interpretations of what today's drop "means." I've already seen one article today displaying how the odds of a bear market shift based on the new year's first day of trading. I'm not convinced.
As most of you know, SMI doesn't make predictions about what's going to happen in the financial markets. We're not big on the abilities of forecasters, having spent much of the past quarter-century pointing out the horrible records of those who attempt to discern the future. So we're not going to run a list of predictions or things to watch for in 2016. But in the busy hustle and bustle leading up to the holidays, we didn't talk much about the events unfolding in the markets. So consider this a list of random musings, in no particular order, regarding the year ahead.
- The Federal Reserve finally boosted interest rates a quarter percent in December. Pundits are all over the place in terms of what the outcome of these rate hikes will be (we included a few varying opinions in the January newsletter). Overall, I'm glad to see them finally trying to "normalize" interest rates, even if this is just a first baby step. Like other significant Fed interventions in recent decades, the unforeseen consequences of holding interest rates near zero for seven years are likely to be unpleasant — eventually. The impact on savers, and the ripple effect on other conservative investors, has already been significant. Returning some semblence of reasonably safe return to the bottom rungs of the investment risk ladder is a good thing.
- Whether the U.S. economy will be able to hold up under the growing strain of additional rate hikes is an open question. I hope it can. But I admit to not being tremendously optimistic. I'm inclined to agree with John Mauldin, who says he thinks it's even money that we see zero percent again before the Fed can get to 2%. In other words, it seems likely that a weakening economy could force the Fed to start cutting rates again before they're able to raise rates too much higher.
- The Federal Reserve meeting notes, as well as subsequent comments by Fed officials, indicate they see as many as 4-5 additional rate hikes in 2016. It's telling that the market is signalling it believes the Fed will raise rates twice iin 2016. That's a bit of a disconnect. Somebody is going to be wrong. If the market has to adjust to the Fed's reality, that could cause some additional volatility. But don't be overly concerned — the Fed blew hot air about the first rate hike for over a year before they finally pulled the trigger. I won't be at all surprised to see the Fed adjust those aggressive aspirations lower as the year moves along.
- Remember this isn't a prediction, but...with the U.S. now raising interest rates, and the rest of the world still easing their monetary policies lower, don't be surprised if the net effect is a rush of foreign money coming to invest in U.S. bonds. Our economy is in better shape than most, and our bonds are going to be paying more as well. If that foreign money does shift this way, supply and demand would indicate that more demand for a product (US Bonds) will push the prices higher and yields lower. Which is pretty much the opposite of what everyone expects to happen in bonds. I'm grateful to have mechanical processes like DAA and Bond Upgrading to tell us whether to stay in bonds, and which types of bonds to invest in.
- The stock market is always tough to predict, which is why we don't even try. I've been on record for years saying that the unprecedented actions of the Fed and other central bankers would push the current bull market farther than anyone expected. That may have been a helpful viewpoint a few years ago, but today we've reasonably met that expectation already. Which doesn't mean their largesse couldn't propel stocks even higher. But as I've noted a number of times over the past 18 months or so, I've personally been scaling back risk in my own portfolio. Nothing that I'm seeing today makes me inclined to tilt back the other way. It's hard for me to believe we escape the biggest of the three Fed-propelled recent bull markets without a corresponding decline of the sort we saw with the first two (2000-2002, 2008).
- The previous point doesn't mean the next bear market is coming in 2016!
- Because we don't know when the next bear market is coming, it's probably foolish to try to take pre-emptive action (like pulling money out of stocks). But that doesn't mean there's nothing you can do to reduce risk. Some strategies are much riskier than others. Personally, I've been scaling back Sector Rotation (the riskiest of SMI's strategies) and boosting Dynamic Asset Allocation (the most conservative, at least of those that can invest significantly in stocks).
- DAA didn't have a great year, which is a bummer since I've been moving money from Sector Rotation into it. Owning insurance usually involves a small cost, so I'm okay with that. At any rate, it's not like DAA underperformed Sector Rotation last year anyway.
- To be fair though, DAA actually lost money, which rarely ever happened in the strategy's 30+ year backtested history. What made last year nearly unique among the past 30 years? No definite answers yet (we may explore this in more depth later), but my first instinct is to point to historically rich valuations for stocks as well as bonds and real estate, at a time when interest rates were artificially repressed to make cash not pay anything. In other words, when everything is expensive and cash yields nothing, it's hard to make money.
- Those conditions are also rare, thankfully, which is why I'm grateful to see the Fed at least making the effort to normalize monetary policy. The sooner the markets can get back to resembling "normal," the sooner the historic models and relationships between asset classes will presumably start working the way they have in the past again too.
That's probably enough stream-of-consciousness investing writing for today. Hope you've had a wonderful Christmas season and a happy New Year! We look forward to traveling this uncertain investment road with you over the year ahead!