ProFutures Investments - Managing Your Money
2015 In Review: It Was A Wild Year In The Markets

FORECASTS & TRENDS E-LETTER
by Gary D. Halbert

January 5, 2016

IN THIS ISSUE:

1. After a Wild Year, Markets End on a Fairly Quiet Note

2. The Outlook For Bonds in the Wake of Fed “Lift-Off”

3. Global Corporate Debt Default Risk Now Highest Since 2009

4. 2015 Was Toughest Year to Make Money in 78 Years

Overview

As we begin another New Year, it is often good to reflect on the year that just passed and what we may have learned from it. Here are some thoughts about the market activity we saw in 2015 and what we may see in 2016.

At the end of last year, most US equity indexes closed about unchanged for the year. Yet during the year, these same markets experienced some extreme volatility as we’ll see below. It was a wild ride for most investors, some of whom bailed out near the bottom as is so often the case.

In fact, a recent report from Societe General (the huge French banking conglomerate) said that 2015 was the toughest year to make money in 78 years; I will discuss that report below. I will also discuss an alarming new report from Standard & Poor’s which says that global corporate debt default risk is now the highest since 2009.

It should be an interesting letter. Let’s get started.

After a Wild Year, Markets End on a Fairly Quiet Note

Wall Street lost ground on the last day of 2015, leaving the Dow Jones industrial Average and the S&P 500 Index marginally lower at the end of a year marked by record highs in some markets, but with a major selloff beginning in late August that shook investors’ confidence.

The Dow closed down 1.03% for the year; the S&P 500 lost 0.95%, not including dividends; and the Nasdaq Composite closed up just over 5% for all of 2015. But the Russell 2000 and Dow Transports both had their worst year since 2008. This disappointing year ended a three-year streak of double-digit returns for most equity markets.

It was a year to make old guard companies shudder. The biggest winners in 2015 were so-called “new media” companies like Netflix, which rose 138% to notch the biggest gain in the S&P 500, and became more valuable than established media companies like CBS. Amazon eviscerated traditional retailers like Macy’s and Walmart, with its stock trading at over 900 times earnings!

The biggest losers in 2015 were mostly energy and materials companies which were hurt by weak demand at a time of abundant supplies. The biggest loser was Chesapeake Energy, down 77% in 2015.

While most major market indexes ended last year about where they started, 2015 was one of the wildest years in recent memory. After failing to breakout to make new record highs several times last year, the equity markets plunged sharply lower in late August.

A wave of selling hit markets around the world in August, propelled by fears that China’s economic slowdown was turning out to be worse than feared. These same China fears reignited over the New Year’s weekend, and stocks around the world plunged sharply yesterday.

S&P 500 Index

Few equity mutual funds and ETFs escaped the tumult that ensued in August. Stock funds gave us a reminder that they can be among the most volatile investments. And many bond funds, which are supposed to be the safe part of our portfolios, delivered losses.

S&P 500 index funds lost 10% or more over the span of just a week in late August, their first drop of that magnitude in about four years. It was a cold slap in the face for investors who had gotten used to several years of above-average returns from their stock funds.

Fortunately, the US stock markets mounted a strong recovery after retesting the August lows, and the S&P 500 Index vaulted from below 1880 to back above 2,100 by early November. But as you can see in the chart above, that strong rally once again peaked well below the highs recorded on several advances earlier in the year.

As always, it remains to be seen what lies ahead for US stocks and stock mutual funds and ETFs in 2016. Most forecasters suggest that US equities will deliver modest positive gains this year, but that is almost always what the New Year predictions have to offer.

For me, the risks in the equity markets remain high. If you followed my advice back in March and April last year to reduce equity exposure by 50%, I would still remain defensive.

For my clients who have money invested with the professional money managers I recommend, you don’t need to take any action at this point. Your selected Advisor(s) will continue to make those decisions for you based on their time-tested systems.

Outlook For Bonds in the Wake of Fed “Lift-Off”

D-Day finally arrived for bond investors on December 16 when the Federal Reserve announced the first increase in short-term rates in nearly a decade. Investors had spent years fretting about an impending rate hike because higher rates tend to cause the price of bonds to fall.

As was widely expected, the Fed Open Market Committee (FOMC) raised the target range for its key Fed Funds rate from 0.00%-0.25%, where it had been since late 2008, to 0.25%-0.50% last month. The Fed suggested that it will raise the rate modestly several more times this year.

Many traditional bond funds did turn in losses for 2015, but they were mostly modest. The largest category of bond funds, ones focused on intermediate-term bonds, lost an average of 0.4% in 2015.

One corner of the bond market – high-yield bonds or so-called “junk bonds” – did experience a lot of turmoil last year, however, but it wasn’t because of interest rates. High-yield bond funds lost an average of about 5.1% last year, worse than traditional bond funds and many stock funds.

These funds invest in bonds with higher yields than high-quality bonds, but they come with extra risk. These bonds are issued by companies considered more likely to default. Sliding prices for oil and metals mean that many commodity producers may soon have trouble repaying their debts, and they make up a big chunk of the high-yield bond market.

About a week before the Fed raised rates, a mutual fund focused on the lowest-quality bonds closed and told investors they may have to wait a year to get their money back. Scared investors pulled cash from other high-yield bond funds, which caused a chain reaction that led to steeper price drops across the junk bond market.

This episode highlighted worries that bond fund managers have had for a while. When they try to sell a bond, they’re finding it more difficult to find buyers. The same goes when they're looking to buy. The greater difficulty in trading is partly a result of new banking regulations, fund managers say, and it is amplifying price swings – but that’s a discussion for another time.

The largest high-yield bond fund, Vanguard’s High-Yield Corporate Fund, lost 1.2% in a single day on December 11, its worst day in four years. Two days later, it had its best day in more than a year. Yet many other high-yield bond funds were clobbered in 2015.

US High Yield Bond ReturnsOn average, high-yield bond funds lost 5.15% in 2015. Some were hit much harder. As noted above, some junk bond funds suspended redemptions and are closing down. It remains to be seen how high-yield bond funds will perform in 2016.

There hasn’t been a negative annual return in high-yield bonds since the supersized loss of 23.4% in 2008 amid the credit crunch, according to the S&P U.S. High Yield Corporate Bond Index (SPUSCHY).

Looking ahead, most forecasters don’t expect the carnage of 2015 to continue, but time will tell. As seen at left, most junk bond forecasts for 2016 range from (-3%) to +6%. As usual, what that means is that no one knows for sure. A great deal will depend on how many bond defaults we see this year.

Global Corporate Debt Default Risk Now Highest Since 2009

I mentioned junk bonds above because a new report from Standard & Poor’s found that the number of global companies with the lowest credit ratings and negative forward outlooks jumped to the highest level in December since 2009.

The bond markets are starting to factor in the dangerous combination of rising interest rates as well as profit weakness in several sectors, both of which contribute to a higher risk of corporate bond defaults.

The US Debt Distress Ratio – a measure of the amount of risk the market has priced into bonds – hit 20.1% in November, which is the highest level since hitting 23.5% in September 2009, says S&P. That’s a troubling indicator since September 2009 takes us all the way back to the Great Recession.

The largest percentage of distressed debt today - 37% - is concentrated in the oil and gas sector. This sector is getting hammered by falling energy prices. But metals, mining and steel are hurting too, with a whopping 72% Distress Ratio. Time will tell if the debt markets can weather all this distressed debt without incurring another credit crisis.

I bring this up because investing in distressed debt has become very popular in the last decade or so. Investing in distressed debt can be extremely lucrative for people and companies that know what they're doing. Like most opportunities for your money, investing in distressed debt should only be done with the help of experienced professionals, such as two of the professional Advisors we recommend.

Distressed debt investing combines the best of both worlds – the cash flow of debt investments with the appreciation potential of stocks. While there is no hard and fast rule for what makes a “distressed” investment, it’s generally accepted that distressed debt trades at a huge discount to par value (think $400 for a $1,000 bond, for instance) because the borrower is under financial stress and at risk of default.

The risks are certainly high, but those who manage their risks well have put up impressive returns over history. Distressed debt investors typically seek to make money in one of two ways: investing in turnarounds and participating in lend-to-own situations.

Distressed debt can be a good way to invest in turnaround situations because debt is given preference to equity in the event of bankruptcy. That is to say that while a stock's value in bankruptcy is usually zero, debt often retains some of its value in a worst-case scenario, limiting downside risk if a turnaround fails.

2015 Was Toughest Year to Make Money in 78 Years

Switching gears again here, 2015 was a really, really  tough year for making money in the markets. According to data from Societe Generale, the best-performing global asset class of 2015 was stocks, whose meager 2% total return (including dividends) still surpassed those of long-term bonds, short-term Treasury bills and commodities.

These minimal gains make 2015 the worst year for finding returns since 1937, when the cash-like 3-month Treasury bill beat out other major asset classes with a meager return of just 0.3%.

Larry McDonald, head of US macro-economic strategy at Societe Generale, said the all-encompassing lag in performance is one reason why major money managers did so badly last year. 2015 was particularly troublesome for hedge funds, the average of which was down about 4% last year according to Hedge Fund Research.  McDonald added:

“It’s been an absolute meat grinder of a year. Hall-of-fame legends, Warren Buffett, David Einhorn, Carlos Slim, those are my favorite investors of all time and they all had bad years."

Investment legend Warren Buffett reportedly saw his worst year since 2008 in 2015, with Berkshire Hathaway shares down more than 11% going into the end of last year. Buffet was certainly not alone as many investment fund managers lost money last year.

In conclusion, 2015 was a tough year for making money for most investors. Stocks went essentially nowhere as discussed above. Bonds disappointed as well. Precious metals prices continued to decline. Real estate prices were mixed, depending on where you invested.

Most forecasters expect another slow year for the US economy in 2016, with GDP growth somewhere in the range of 1.5% to 2.5%. This suggests another challenging year for how to best invest our money.

I’ll be sharing my best ideas on how to do that in the weeks and months ahead.

Wishing you profits in the New Year,

Gary D. Halbert

 

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Read Gary’s blog and join the conversation at garydhalbert.com.

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