February 5th, 2016 2016 Stock Market Turmoil – What to Watch & What to Do – by Matthew M. Neyland, CFA, CAIA, Director of Investments, SK Wealth Management, LLC Most investors have been caught by surprise by the negative and very volatile start to 2016. The strong performance of a few stocks over the last 12 months has masked overall weakness that has persisted in the stock markets. The larger S&P 1500 and the S&P 600 Small Cap Index are both down over 20% from their 52-week highs. Remember the adage – The stock market is not the economy, and the economy is not the stock market. Nonetheless, many are convinced that the market correction of the past few weeks is a certain sign of impending recession. What is interesting about the current pullback is that it is divorced from fundamentals. While the U.S. is clearly in a manufacturing recession, other data doesn’t suggest reason to panic – outside of energy. For example, there certainly aren’t clear examples of rampant capital misallocation coming home to roost, like when the housing bubble burst in 2008. Just like we experienced in 2015, global stock markets are likely to be driven more by drama than data. What to Watch for in 2016 Economic Growth or Recession? – History shows that economists’ consensus forecasts do not foresee a recession until it hits. But they provide a useful base case for your planning. Most professional economists remain sanguine about the US economy in 2016. At the most recent meeting of the Fed Open Market Committee on December 16, its members expected real GDP to grow 2.6% this year. The Fed’s survey of professional forecasters on November 13 had the same prediction, and saw a roughly 13% chance of a downturn in Q1, Q2, or Q3. Business cycles don’t suddenly occur or die for no reason. The last 15 recessions have all been triggered by something that robbed consumers of their jobs and their spending power. In 2016, the US worker and consumer may look vulnerable. Yet wages have been rising, and cost-of-living increases appear negligible. Oil – Stability in oil prices even at low current levels would be a positive for the financial markets. Crude prices have been under downward pressure for nearly 18 months due to rapid growth in supply and the strategy of top OPEC producer Saudi Arabia to favor market share over price support via output cuts. Current projections for global supply and demand indicate that oil inventories should continue to build through at least the third quarter of 2016, despite a dramatic drop in the U.S. onshore rig count. Normally, falling rig counts would lead to a major decline in U.S. onshore production over the following 12 months. The key point to watch for will be the peak in Two factors that could lead to oil upside before the peak would be a change in Saudi Arabia’s strategy to subordinate price to market share (something that appears unlikely at this point), or a clear indication of the expected 2016 U.S. production decline. U.S. Interest Rates & Central Bank Policy– The Federal Reserve raised short-term interest rates for the first time since 2006 this past December. Even though it is a sign of economic strength, it spooks investors. Market expectations for future Fed rate hikes have been slowly converging toward a more patient approach to rate increases. As long as the U.S. economy continues its current slow but steady course, its likely current expectations are met and we see a few small rate hikes in 2016. Without an uptick in inflation expectations—something hard to imagine during a period of continued dollar strength—the Fed is unlikely to raise rates aggressively. China– Many people ask why China has such an impact on the markets. Now that China is the world’s 2nd largest economy, its growth has a ripple effect throughout the global economy. China’s slow transition from an investment-led to a consumption-driven economy has been more difficult than expected. The recent moderation of growth in China is an inevitable normalization for an economy of its size; its nominal level of gross domestic product (GDP) is now five times the size of what it was 10 years ago. Thus, a lower rate of growth still represents a massive level of global aggregate demand. It’s worth noting the remarkable resolve Chinese policy makers have shown as they continue to support the transition, despite the sharper-than-expected growth slowdown. China’s leadership is well aware that turning back to old-growth methods based on easy credit and unnecessary infrastructure programs would be a major setback for the reform movement. Nevertheless, the uneven economic data points amidst an overall deceleration in growth for China are likely to contribute to volatility in 2016—as seen already in the year. Action Plan Don’t Try to Time the Market – Resisting recency bias is the greatest struggle for most investors. Unfortunately, most investors never overcome it. In fact, depending which study you look at, individual investors seem to sacrifice more than 2% of annual returns (and often much more) by trying to time the market. This may not sound like a lot, but over time, that adds up. From a portfolio perspective, there are numerous “systematic” ways to avoid this sort of emotionally driven fear – dollar-cost averaging, holding some cash or short-term bonds and rebalancing on a quarterly or annual basis. Be Patient and Systematic – Many experts tell you to focus on the long-term but long-term means different things to different people. You don’t have to be irrationally long-term, but focusing on the short-term is just as irrational. You should use this period of volatility to assess your current portfolio allocation strategy. You need to ensure that your risk profile is aligned with your asset allocation. For example, in the last 45 years a globally allocated 60/40 stock/bond portfolio has never had a negative rolling 5-year return. Tax-Loss Harvesting – One of the few benefits of down markets is to improve your tax liability situation. As the markets have moved higher over the last few years there have been limited opportunities to harvest losses vs. gains. Tax-loss harvesting involves selling a security that has lost value in your portfolio and buying a similar security. By disposing of the asset at a loss, also known as realizing, or harvesting, you may be able to offset capital gains taxes. Even without capital gains to offset, selling depreciated assets may allow you to reduce current ordinary income by $3,000 or carry the loss forward to future years. Consult your financial planner and tax accountant to devise a plan appropriate for your situation. [Article] as it appeared in PBN.