The S&P 500 large caps closed 2015 essentially flat on a total return basis, while the NASDAQ 100 showed a little better performance at +8.3% and the Russell 2000 small caps fell -5.9%. Overall, stocks disappointed even in the face of modest expectations, especially the small caps as market leadership was mostly limited to a handful of large and mega-cap darlings. Notably, the full year chart for the S&P 500 looks very much like 2011. It got off to a good start, drifted sideways for a few months, threw everyone into a tizzy with a scary summer correction, found double-bottom support leading to a strong October rally, and then fell into a sideways consolidation for the last two months of the year. It’s like deja vu. In both years, a sideways channel set the trading range most of the time, and without a strong catalyst, there simply wasn’t enough fuel to ignite a major breakout for either the bulls or the bears.
In contrast to 2015 ending as it did with a whimper, the first trading day of 2016 was downright scary (the worst opening day for the Dow Industrials in eight years) — as if to give fair warning of a more volatile year ahead. But higher volatility wouldn’t necessarily be a bad thing, as investors and corporations may be more inclined to allocate capital with an eye toward risk exposures, i.e., a flight to quality, including value, GARP (growth at a reasonable price), and dividend-paying stocks. We just might end up looking back on 2015 as a cautious year of transition out of the ZIRP era.
In this weekly update, I give my view of the current market environment, offer a technical analysis of the S&P 500 chart, review our weekly fundamentals-based SectorCast rankings of the ten U.S. business sectors, and then offer up some actionable trading ideas, including a sector rotation strategy using ETFs and an enhanced version using top-ranked stocks from the top-ranked sectors.
Market overview:
Yes, U.S. stocks mostly disappointed investors last year, although few market commentators at the beginning of the year were expecting much in the way of returns for the stock market to begin with — perhaps at best seeing prices move up in proportion to aggregate earnings growth. But aggregate earnings growth didn’t materialize, thanks mainly to the dismal performance of the Energy sector.
From a global perspective, the top performing countries (measured in constant US dollars) last year were Hungary +30%, Denmark +22%, and Ireland +17% — and all rose much higher when measured in their local currencies as the dollar strengthened considerably against almost all other currencies. For example, Hungary was up +44% in its local currency (forint). On the bottom of the stack, the worst performers were Colombia -45%, Brazil -42%, Turkey -33%, and Greece -31% (measured in US dollars). Looking at our neighbors, Canada fell -25% in US dollars (-11% in CDN dollars) and Mexico fell -15% (but it was flat when priced in pesos).
But if you were focused on the U.S., it was tough to find anything that worked in the way of liquid asset allocation/rotation. In fact, 2015 was one of the worst for asset allocation strategies in several decades, as stocks, bonds, commodities, and cash all lost money. Seven years of ZIRP monetary policy helped inflate stocks, Treasuries, and high-yield bonds, and there was simply nowhere to find refuge once the Fed made it clear that the first step toward interest rate normalization was nigh. Most years offer up at least one asset class for superior returns, usually exceeding 10%. And indeed many of the biggest names in the business had a miserable year, from Warren Buffett’s deep value approach to David Einhorn’s long/short activist strategy.
It was a year of narrow market breadth, particularly after small caps hit their peak on June 23. To illustrate, just look at the performance difference of the cap-weighted SPDR S&P 500 Trust (SPY) versus the equal-weighted Guggenheim Russell 2000 Equal Weight ETF (EWRS). Since June 23, SPY fell -3.2% through December 31 while EWRS fell -15.2%. That’s a whopping 12% performance differential.
One of the drivers of this was the growth in money flows into passive index funds, which have a far different and simplistic approach to stock selection compared to the careful analysis of active management. During 2015, approximately $150 billion flowed into passive index funds while roughly the same amount was flowing out of actively managed mutual funds. Moreover, if you weren’t in the handful of large-cap investor darlings, particularly the so-called FANG stocks (Facebook, Amazon, Netflix, Google), your portfolio likely struggled. The four FANG stocks alone boosted the S&P 500 overall performance by +2%, with Netflix (NFLX) and Amazon.com (AMZN) each more than doubling.
