Investment Year in Review 2015

Volatility increased for investors in 2015. Domestic stocks experienced 10 days of a 2% or greater price movement, the largest number since 2011. This volatility was relatively minor when compared to locally traded Chinese shares that experienced 85 days of a 2% greater price movement. The volatility in China largely stemmed from concerns about excess valuations on the locally traded shares; however, when combined with uncertainty surrounding the pace of global economic growth, falling commodity prices, and unstable currency exchange rates, there were plenty of reasons for the increased volatility to spread across the globe.

Early in 2015, emerging market and foreign developed stocks rose well above domestic shares, but this gain was only temporary. By mid-year, foreign stocks started a decline that would eventually lead to slightly negative returns for foreign developed shares and double digit losses in emerging markets. Commodities were by far the biggest disappointment for investors as falling oil prices contributed to a decline of nearly 25%.

Major asset class returns.

Oil – how low will it go?

The latest figures indicate that domestic oil production has increased more than 20% over the past few years. With demand for oil increasing only modestly, prices began to adjust to the supply and demand imbalance in the second half of 2014. In addition, the refusal of OPEC members to reduce production and the lifting of sanctions on Iran has put further pressure on oil prices. As a result, oil has dropped from just over $115 per barrel in June of 2014 to less than $37 per barrel at the end of 2015.

Core bonds vs. non-core bonds.

Bond returns over the past twelve months have served as a good reminder of the difference between “core bonds” and “non-core bonds.” Returns of safer, investment grade bonds such as short and intermediate term treasury bonds were positive during 2015. In contrast, riskier areas of the bond market such as leveraged loans, high yield corporate bonds, and local currency emerging market bonds were all negative.

One casualty of the difficult environment for risky bonds was New York-based Third Avenue Management that took the unusual step of blocking investors from getting their money out of its Focused Credit fund. The nearly $1 billion fund was heavily invested in some of the lowest rate junk bonds. The demise of the fund has renewed fears that lower levels of liquidity in the riskier areas of the bond market will cause increased volatility.

Central bank activity.

The Federal Reserve decided to increase short term interest rates in response to substantial progress toward achieving its objective of maximum employment and its reasonable confidence that inflation would move to 2% over the medium term. However, some members stated that their decision to raise rates was a close call, particularly given the uncertainty about inflation dynamics, and emphasized the need to monitor the progress of inflation closely.

Analysis of the Fed’s press release revealed that many members believe four additional rate hikes would be appropriate in 2016. The actions of other central banks, however, may make this difficult. At a time when the European Central Bank and the Bank of Japan are continuing monetary stimulus in the form of both exceptionally low interest rates and monthly large scale asset purchases, would several additional rate hikes be possible?

Realities of low inflation.

With the general level of inflation low over the past several years, especially when looking at energy and commodity prices, there has been little pressure to raise wages and benefits. Wage increases have hovered around 2% over the past several years, while social security increases have been even lower. In fact, with the 2015 social security cost of living adjustment at zero, there will be no increase in social security checks in 2016.