The year closed out with a whimper instead of a bang as the majority of asset classes had negative returns for the month. Commodities and Emerging Markets were the weakest assets during December, and for 2015 as a whole. US stocks and bonds ended the year slightly positive, while international developed markets lost 1% for the year. The last twelve months left little changed in the way of leadership of these assets. US stocks continue to outperform, even while they were flattish in 2015, while commodities and emerging markets continue to lag other assets:
Looking at the bar chart below of returns over the last 12 months, it's worth noting that between stocks, bonds and commodities, last year was the weakest series of annual returns since 1937. During other recent years of stock weakness, bonds or commodities outperformed. But this year, bonds were flat and commodities performed even worse than stocks. This scenario is unlikely to be repeated in 2016, but it does highlight the emergence and rapid growth of "Liquid Alternatives" in recent years, which seek to perform differently than any of these three major investible asset classes. Money managers are looking for assets that can add value and provide stability at times when the basic investment building blocks do not:
Investors in December were handed two key central bank decisions. The first came from the European Central Bank on December 3rd, which cut their deposit rate from minus .2 percent to minus .3, a record low. After the decision, the ECB affirmed that it will continue its version of Quantitative Easing ("asset purchase program") by buying up to 60 billion per month in bonds and loans until March 2017 "or beyond", if necessary.
It is hard to see how this will help improve their economy, which is now effectively taxing capital through a negative deposit rate. Small businesses in particular, which need to hold reserves for unforeseen events, will likely hold less cash, with "hoarding" in general a logical reaction by all savers. With tax receipts falling and economic growth tepid, some are now calling for an outright ban on cash and complete conversion to electronic money (the better to collect taxes and curtail "tax avoidance"). Big Brother appears to be alive and while and thriving in Brussels!
The second announcement was the long anticipated rate hike from the US Federal Reserve. On December 16th, they raised the target range for short term lending from 0 -.25% to .25-.50%, the first rate hike in nine years. (Most banks immediately increased their "Prime Rate" from 3.25% to 3.50%.) However, the Fed made it clear that it might be some time before rates "normalize": "The Committee expects that economic conditions will evolve in a manner that will warrant only gradual increases in the federal funds rate; the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run. However, the actual path of the federal funds rate will depend on the economic outlook as informed by incoming data."
Students of the market know that rate increases, once begun, generally continue for some time. In this case, there is great concern that the Fed may be committing a "policy error" by beginning a rate raising regime just as the economy is showing signs of weakness. It is possible that, in the not too distant future, the Fed may be forced to ease again, if more economic data tilts towards "recession".
At a minimum, with the ECB and Fed moving in different directions, the US Dollar should become even more attractive versus other major currencies. The US Dollar Index broke out of a multi-year slump beginning in July of 2014, and its unanticipated and sustained rise is causing lots of havoc in overseas markets, not least of all in China. In a little noticed announcement in December, China laid out a new framework for valuing its currency, which effectively will break its peg to the US Dollar. For all the talk of devaluing the yuan, it has actually risen along with the US Dollar against its major trading partners, making China less competitive with other exporters. The chart below shows just how "expensive" China has become:
Tired of losing market share, and highly sensitive to social unrest that might come from the loss of jobs, the People's Bank of China (PBOC) basically said that going forward it will consider the (de)valuation of its currency not only versus the US Dollar but versus all key currencies.
Most observers think that the yuan will need to come down by 10-15% to make them competitive again as an exporter. Until then, it is argued, we should expect to see weaker growth out of China (leading to a weaker Chinese stock market, which, not coincidentally, was halted for trading on the first trading day of 2016 after a 7% decline). Capital flight out of China is a likely result of this new currency devaluation policy, and much of it, we think, may be headed for the US. Investors should expect to see a much more aggressive de-valuation of the yuan going forward (and a concomitant rise in the accusations of "unfair trade" practices by the Chinese). This is a sleeper story for 2016 that should be migrating to Page One.
Lastly, the political earthquakes that have erupted this year continued as Venezuelans overwhelmingly voted for opposition candidates to the socialist government, giving them a considerable majority in the national assembly. Jubilant opposition leaders said the result was the beginning of a new political era for the country with the world's largest oil reserves. After 17 years of "socialist paradise" implemented by Hugo Chavez, Venezuelans had apparently had enough of empty store shelves and worthless currency (inflation is currently running over 600%!) In a quote by a noted expert that could be applied to every major election soon to come around the world, it was noted pithily that "the country is clearly signaling the need to enter a process of change."
2016 is shaping up to be quite an interesting year, especially with the US presidential campaign ready to take center stage. We'll send out our next Journal in early February. Thanks for reading!
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