Happy New Year!
What a roller coaster ride of flatness in the S&P 500 for the year 2015. Yet despite short-term negative investor sentiment (see short term signals on page four), the markets may be poised for more constructive results in the year ahead. Two reasons stand out. First, the probability of a recession going into 2016 appears remote with government spending (Congressional spending bill) and consumer spending (low unemployment and low fuel costs) on the rebound. Secondarily, the European Central Bank’s strategy to pump cash into the Europe economy to stimulate economic growth is working.
The European Central Bank remains committed to quantitative easing. This strategy worked to raise the price of stocks in the United States from 2009-2015. So now the European Central Bank is taking a similar tack. It will not only make a difference, but according to the head of the European Central Bank, it already has. To illustrate, while the S&P 500 was largely flat this year, the Italian and German Indexes were up some 13% and 9% respectively for 2015. Moreover, at present, the European Central Bank plans to continue creating new money at the rate of 60 billion Euros per month through at least September of 2016.
By overweighting European stocks in 2016, we hope to benefit from the equity risk premium advantage. That is, the equity risk premium is the expected excess return an investor can expect to earn over and above government treasury bonds by holding stocks. The U.S. securities market currently sports a 5%+ equity risk premium while the European markets sport an 8%+ equity risk premium. This means you are likely to obtain a higher return from your risk taking in European stocks when compared to U.S. stocks.
As you know, past performance is no guarantee of future results. Nevertheless, investors should not dismiss the fact that two back-to-back years of weakness in the U.S. equities markets is rare, especially when coming into an election year. Besides, neither the Democrats nor the Republicans want federal spending to dry up. The Republicans want to facilitate economic growth just before they retake the White House, while the Democrats need further economic expansion to prove they deserve to keep the White House. This is one of the primary motivations behind a bipartisan bill just passed this month called FAST or Fixing America’s Surface Transportation. The bill funds some $300 billion of infrastructure and highway spending over five years. This federal spending initiative will support government spending going into 2016 and beyond, in addition to the big dogs: military and entitlement spending. It is up to the Federal Reserve Board to keep interest rates low in order to keep the cost of funding the federal debt low.
The Federal Reserve Board has a duel mandate to manage inflation and unemployment. Their jobs mandate is largely complete. Unemployment is low. Now their attention is on raising interest rates in anticipation of remaining one step ahead of inflation, even though many economists claim that the real Fed strategy involves planned rate hikes to fund bank lending and encourage public spending on large-ticket items before the cost of leverage goes higher. The result is to pull future growth into the present. Of note: during periods of Fed tightening, growth-as-a-style has outperformed the markets in two of the last three tightening cycles.
This growth as a style includes small capitalized companies. In particular, U.S. and European small cap stocks are expected to outperform in 2016. Why now? Large U.S. manufacturing companies are engaged in significant Chinese competition, while small U.S. and European companies are not affected by the growing threat of Chinese competition. Ultimately, China is engaged in employment rather than profit maximization. The steel and aluminum industries provide a good example of this where nearly all production results in losses and yet China continues to be a major exporter of both commodities. As for European and U.S. small cap companies, several themes fall into the realm of opportunities in 2016, a partial list includes:
- U.S. and European domestic consumer demand improvement
- U.S., European and global retail banks’ earnings momentum
- Insurance companies do well during periods of rising interest rates
- German residential property REITS. Current low rates make it cheaper to buy than to rent.
- Airlines are a play on the European consumer as passenger growth is double that of GDP growth
- Tourism: 11,000 Baby Boomers retire daily, obtaining their first ever monthly social security check.
- The Internet of Things: embedded electronics, sensors, software, connectivity
- The Sharing Economy: collaborative consumption as a phenomenon.
- Construction materials: the FAST bill is passed (Fixing American’s Surface Transportation bill)
- Biopharma: the Emerging markets are experiencing the aging of their citizenry at twice the rate of the developed word.
- Oil bottom: expectations are growing of a value opportunity in the oil patch which may emerge as soon as the end of February 2016.
For the Year: 2016 Summary, Thematic Perspective
Themes: China as a competitive threat; the undervaluation of the internet-related names; opportunities from aging in Global Emerging Markets. Our key macro themes are: the beneficiaries of a domestic recovery in Europe and selective Global Emerging Market exposure via developed market stocks.
Style: We stay overweight growth as a style and raise small cap to overweight in both Europe and the US.
Sectors: From a European perspective, according to Credit Suisse Research, 2016 is a year to deploy a strategy that emphasizes the European economic recovery via an overweight in financials, airlines, software, telecoms, insurance banks, large-cap pharma, auto components, advertising and German REITs.
Current Short Term Signals for January
The overbought/oversold oscillator remains overbought, suggesting a two week initial period of underperformance leading to a rally in the last two weeks of January off of an oversold market posture. This may suggest a rally in the materials and oil market during the same time. It may also suggest further strength in the consumer and real estate markets and possible news from the Federal Reserve Board that muted inflationary news suggests further rate hikes are unlikely for a while.
Vaughn L. Woods, CFP®, M.B.A.
Investors should be aware that there are risks inherent in all investments, such as fluctuations in investment principal. Past performance is not a guarantee of future results. Asset allocation cannot assure a profit nor protect against loss. Although the information has been gathered from sources believed to be reliable, it cannot be guaranteed. Views expressed in this newsletter may not reflect the views of Bolton Global Capital or Bolton Global Asset Management. The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. VW1/VWA0211.
Global Equity Strategy, 2016 Outlook: themes, sectors and styles: December 18, 2015, Andrew Garthwaite, et al.
CNN Money, Europe finally starts pumping markets with cash, Mark Thompson, March 9, 2015.