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These are the charts and themes that tell the story of 2015.
After seven years of 0%, the Federal Reserve at long last increased interest rates by 0.25% in December.
Remarkably, they did so against a backdrop of easing by virtually every other major global central bank. Australia, Canada, China, Denmark, India, Indonesia, Norway, Russia, South Korea, Sweden, Switzerland, Turkey and the ECB all cut rates in 2015.
The ECB moved further into negative territory in early December, just weeks before the Fed hike.
Draghi also announced an extension of the QE program he started earlier in the year. With U.S. QE over, the Fed’s balance sheet growth has flatlined over the past year versus a growing balance sheet in Europe (ECB) and Japan (BOJ).
This Great Divergence in monetary policy between the U.S. and the rest of the world would have ripple effects throughout the financial markets.
We’ll start with bonds and interest rates. Yields hit all-time lows in Europe throughout the year.
Meanwhile, U.S. rates hit multi-year and expansion highs throughout the year. With similar rates of inflation and growth, the spread between U.S. and German yields was an incredible disconnect that would have a great impact on currency markets (see next section).
The combination of Fed tightening, global easing, and a commodities crash was a powerful force in driving every currency in the world lower against the U.S. dollar.
This sharp decline in global currencies versus the U.S. dollar would in turn impact U.S. manufacturing, earnings of multi-nationals, and commodities.
The consensus entering the year was that U.S. economic growth was going to finally breakout in 2015 with a decoupling from the world. We saw just the opposite, with manufacturing and industrial production in the U.S. declining to recessionary levels.
The consensus entering the year was for earnings to expand double digits in the U.S. with stronger revenue growth. The combination of a stronger Dollar, weaker Crude oil and lower overall economic growth was grossly underestimated and we saw the complete opposite.
S&P 500 earnings have now declined for four consecutive quarters while revenues have declined for three straight quarters.
The rise in the Dollar, slowdown in global growth, and increased supply all contributed to the third consecutive down year for commodities. Many commodities hit multi-year lows in 2015 with dramatic declines from their all-time highs.
Garnering the most attention was the continuation of the epic decline in Crude Oil.
Surprising most investors, this longest downtrend in history for Crude Oil (358 trading days and counting) coincided with higher U.S. equity prices. The notion that the S&P 500 needs higher Oil prices is indeed a myth.
Undoubtedly, though, the crash in Crude has had a large impact on the credit markets. High yield bonds spreads widened dramatically throughout the year, more than doubling from their cycle lows set back in June 2014.
The distressed bond market was also hit hard by the unrelenting decline in commodity prices.
Which brings us to the equity markets. In early 2015 saw the end of the v-bottom formation that began in late 2012.
March marked the sixth anniversary of the U.S. equity Bull Market that began in 2009. It was one of the greatest 6-year runs in history for U.S. equities, leaving valuations at the higher end of the historical spectrum. As I commented at the time: “If trees don’t grow to the sky, then, future returns will have to suffer because past returns have been so strong.”
The S&P 500 would trade sideways until August when the S&P 500 experienced its first 10% correction since 2012. “Reasons” for the correction were long, including Greece, China, Fed Rate Hike Fears and Emerging Market turmoil.
U.S. markets would quickly bounce back with the S&P 500 posting yet another year of outperformance versus the rest of the world.
Though hitting its peak back in May, the S&P 500 is set to post a positive return for the seventh consecutive year. This is the longest streak since the 1990’s (nine consecutive positive years from 1991 – 1999). The return of 2% outpaced much of the world when viewed in U.S. dollars, while local currency returns for many countries were higher.
The 2% total return for the S&P 500 was defensive in nature, with low volatility (+5.1%) significantly outperforming high beta (-12.5%).
The overall advance in large cap U.S. stocks, particularly the “FANG” names (Facebook, Amazon, Neflix and Google), masked broader weakness in small caps (-3.5%).
We also saw weakness in value stocks which declined -3.2% in 2015 versus a gain of +6.5% for growth names.
The positive overall return in the S&P 500 was anything but a straight line, masking a significant increase in volatility during the year as we’ll cover in the next section (for our research on volatility, click here).
During a six-day stretch in August, the Volatility Index (VIX) would rise from low of 12 to a high of 53, its largest spike in history.
This volatility of volatility would cut both ways, with the three largest monthly declines in the VIX Index all occurring in 2015.
The increasingly manic nature of the equity market can likely be attributed to many factors. Some of this is a mere normalization as we have transitioned away from the serenity of the low volatility outlier that persisted from late 2012 through the middle of 2014.
But there are other factors at play here as well. The increasingly short-term focus of market participants and growing use of index/ETF products is certainly a contributor. The increasing obsession with the Federal Reserve and the long-awaited shift away from 0% policy also likely played a significant role. Whatever the reason behind it, the rapidity of these risk-on and risk-off moves was a noticeable change in behavior in 2015.
IX. O Reflation, Where Art Thou?
The biggest question for global markets in 2016? Will we finally see a reflationary environment take hold.
In 2015, we saw just the opposite, with U.S. CPI (YoY) dipping below 0% for only the 2nd time in the past fifty years.
Breakeven inflation rates hit expansion lows during the year.
The yield curve (10-year minus 2-year yield) flattened in 2015, hitting new expansion lows.
The consensus view today is that these deflationary trends will continue in 2016, but as we learn each year the recent past is not necessarily the future.
A bounce in inflation expectations and a steepening of the yield curve accompanied by a stabilization in commodities and currencies would be a dramatic shift in markets. It would also likely be a welcome shift, providing the foundation for another leg higher in stocks. That is the glass half full view, of course, that higher growth is on its way and with it stronger earnings and revenues. In this view, cyclicals, higher beta stocks, and emerging markets would at long last show some sustained leadership.
As it is New Year’s Eve, let’s end with this positive scenario and leave our fears and worries for another day.
X. Happy New Year
These were the key charts and themes of 2015. As always, the narrative followed price. As prices change in 2016, the narrative will change with it.
Most of these themes were surprising, if not shocking to many. In 2016, I predict one thing: you will see many more surprises. That is the nature of markets.
Thank you for your readership in 2015.
Wishing you all a happy, healthy and prosperous New Year.
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This writing is for informational purposes only and does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction, or as an offer to provide advisory or other services by Pension Partners, LLC in any jurisdiction in which such offer, solicitation, purchase or sale would be unlawful under the securities laws of such jurisdiction. The information contained in this writing should not be construed as financial or investment advice on any subject matter. Pension Partners, LLC expressly disclaims all liability in respect to actions taken based on any or all of the information on this writing.
Charlie Bilello is the Director of Research at Pension Partners, LLC, an investment advisor that manages mutual funds and separate accounts. He is the co-author of three award-winning research papers on market anomalies and investing. Mr. Bilello is responsible for strategy development, investment research and communicating the firm’s investment themes and portfolio positioning to clients. Prior to joining Pension Partners, he was the Managing Member of Momentum Global Advisors previously held positions as an Equity and Hedge Fund Analyst at billion dollar alternative investment firms.
Mr. Bilello holds a J.D. and M.B.A. in Finance and Accounting from Fordham University and a B.A. in Economics from Binghamton University. He is a Chartered Market Technician (CMT) and a Member of the Market Technicians Association. Mr. Bilello also holds the Certified Public Accountant (CPA) certificate.
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