After starting flat-footed, 2016 is showing signs of life. The U.S. stock market is challenging the record books again, and the economy—while not on fire—is chugging along with employment numbers particularly looking better than they have in many, many years—a key indicator for even better times ahead, but with the warning that inflation may pick up down the road, which is something that will finally drive interest rates back up to more normal levels. The old adage “sell in May, and go away” has a pretty spotty track record and may be particularly bad advice this year. As we mentioned in the last edition of this newsletter, “Camarda believes that stocks will continue to perform for the next year at least, for several reasons. Among them: 1) U.S. economic data continues to improve with employment and inflation [at last!] both up 2) the Fed appears set to slow the pace of interest rate increases, weakening the dollar (good for exports and big companies’ bottom lines), and leaving few alternatives to stocks for investors seeking even modest returns, and 3) oil seems to have—for the moment at least—bottomed hard and bounced from the low 20s to over 40, alleviating a concern that had—somewhat irrationally—scared the dickens out of investors around the world.” So far, these expectations seem to be holding true as we move into summer.
We expect the U.S. economic outlook to remain good but not great, and expect Europe to brighten considerably over the next year; we are neutral on Asia and most emerging markets (despite the recent rally in many of their stock markets) and slightly negative on South America. We see U.S. interest rates going up slowly—still bad news for bonds—with most of the rest of the world hovering at or below zero into at least 2017. After the big pop in the dollar driven by last year’s expectations of faster U.S. interest rates increasing, we are neutral at least going into next year now that the dollar has come down again, and note that this should stimulate U.S. exporters but contribute to eventual inflation as imported goods become pricier. We remain very bearish on bonds of nearly every stripe, and believe that the inevitability of interest rate hikes will mean big losses (either in bond value losses or reductions in purchasing power) for most bondholders.
Looking at investment classes, we are most bullish on inflation-protected bonds and floating rate notes in the fixed income space. As noted last month, the fairly-to-overvalued U.S. stock market, while still buoyant, is probably best approached from a value perspective, and we particularly like U.S. small cap value stocks now. We especially like non-U.S. value stocks across the cap range (big ones, small ones, medium ones), and also think that Europe is very cheap right now. We are neutral on most other equity asset classes, but somewhat bearish on real estate, which is showing some signs of bubbly behavior.
Once again, we believe that a new bear market will eventually come, but not in the near term. When we do get a significant downdraft, most investors will probably be best served by staying invested and riding out the turbulence rather than trying to time the market, an exercise that most practitioners—even highly trained professionals—find disappointing at best. The great meltdown of 2008 provides many heartbreaking examples of investors who sold at or near the bottom, then stayed in cash—some for years—missing most of the rebound. While this huge bear market was painful, those who stuck to their guns eventually did quite well, and perhaps did much better than those who were swayed by emotion and made a long-term decision based on short-term information. Over the long term, the stock market has done very well for nearly every significant period, and investors who find a way to make peace with riding this wave are usually richly rewarded. While we believe the path forward to be a bit uncertain and that our investment decisions and selections should be especially deliberate, remembering the long-term tendency of the markets helps us to overcome the anxiety of day-to-day price moves, ignore distractions, and stay more comfortably on the path to wealth.
