"Kee" Points with Jim Kee, Ph.D.

2015: Overall the total return for US stocks in 2015 (Price appreciation plus dividends) was about 1.4%. Global stocks on balance did about the same. The market (S&P 500) started off the year fairly strong with a 3.5%-4% gain through July, followed by a -12% decline or “correction” in August. It ended the year down slightly (-.7%), but adding in dividends resulted in the positive 1.4% total return. Not stellar, but not a horror story. And horror stories were out there, particularly in alternative investments. In fact, on average, negative returns were experienced by many of these so called diversifiers, including high yield bonds, emerging market bonds and stocks, hedge funds, Master Limited Partnerships (MLPs), and Real Estate Investment Trusts (REITS).

 

This is interesting: Of the ten broad economic sectors, the Consumer Discretionary sector did the best, but the median return for those stocks was -20%! In other words, if you sorted the 242 consumer discretionary stocks in the S&P 1500 (small, mid, and large) from best return to worst return for 2015, the middle or “median company” was down -20%. That means that the sector’s returns were driven by just a handful of stocks, like Netflix and Amazon. Making big bets on just a handful of stocks could have paid off big - but it also could have literally wiped you out. The -70% decline of Valeant Pharmaceuticals this year is a great reminder of the importance of diversification at the company level. This was the second most widely held position among hedge funds, and it was owned by numerous “5 star" mutual funds*. Peer-reviewed research indicates that you generally want to own enough stocks (at least 50) to be diversified, but not too many (over 100) or you’re over diversified.

 

The worst sector for 2015 was Energy. Again. Energy was the worst performing sector in 2014 as well. A lot of people made big bets on Energy at the beginning of the year, citing the “be brave when others are fearful" mantra, only to lose their shirts as energy took another leg down. I have seen this over and over again, whether in Energy, or Financials prior to that, or Technology prior to that. In my experience, it has been the number one career destroyer among investors that I have known.

 

What’s ahead? When I was a sell-side (Wall Street) strategist we used to regard forecasting as attempts to “read the Wall Street Journal in advance.” The correction in stocks that occurred last summer largely reflected a host of confirmation signals that China was still slowing. It was also the period in which oil first fell below $40 per barrel, a big destabilizer for the world’s already volatile oil-producing regions. Most analysts/economists see these factors stabilizing in 2016, which leads to forecasts of positive but probably below average returns for stocks. I find this view to be plausible but would perhaps back-end load it for the second half of the year. That’s because the US economy grew at just 2% in the 3rd quarter, looks to have grown a bit less than 2% for the 4th quarter, and is now in the first quarter of the New Year, which is on average the weakest. So I think we might see a lot of growth concerns (here and abroad - e.g. China) and “Fed on pause” talk early in the year, which means a lot of volatility, but positive returns from there on. That’s my attempt at “reading the Wall Street Journal in advance.” I’ve mentioned in prior Kee Points that a flat market two years in a row would be a rare occurrence.


*Source: Bloomberg