2015
was a disappointing year for investors.
The best of the stock indexes was the S&P 500, which fell 0.7% for
the year, its worst return since 2008.
Including dividends, its total return in 2015 was a slightly positive
1.4%. Returns of U.S. small stocks were
-4.4% in 2015 (the Russell 2000), while returns on established and emerging
international stocks in 2015 were -0.8% and -14.9%, respectively. The total return of our blended equity index
was -1.4% for the year (60% large U.S., 15% small U.S., 15% established
international, and 10% emerging market stocks).
High initial valuations (as we have pointed out previously), concerns
about the Fed’s December increase in short-term interest rates, weak earnings
growth, China, and commodity prices all likely contributed to these
returns. Additionally, U.S. markets were
unusually “narrow” and hostile to dividends in 2015. On average, the 74 non-dividend paying
members of the S&P 500 rose 3.9%, while its 426 dividend paying members, on
average, fell 5.2% for the year (in the long run, dividend paying stocks have
outperformed non-payers by nearly 2% per year).
Taxable
bonds returned 0.6% for the year. REITs
returned 2.8% (with private real estate holdings doing much better). Considering
some specific investments, market risk hedge strategy holdings were generally
slightly positive. Inflation hedges were
the worst of all, generally in the -14% to -17% range for the year for the year
while inflation was +0.8%. A modestly
bright spot in portfolios was insurance linked securities, with the relatively
more conservative Swiss Re Cat Bond Total Return Index returning 4.5% in the
year and more aggressive “quota share” mutual funds returning 7.9% and 9.9%.
Inflation
hedges merit special comment. Gold,
diversified commodities, pipeline master limited partnerships (MLPs), and
energy royalty trusts each contributed to losses, while managed futures
produced modest gains. Inflation has
been all but absent recently but history says this period is an
aberration. We have no opinion as to
when inflation may return, but we believe that when meaningful inflation does
return, it will pose a significant (and greatly unappreciated!) risk to your
portfolio. You own these holdings as an insurance policy for the rest of the
portfolio, and we continue with a standard allocation to these assets of just
under 5% of portfolios.
The
other really poor performer was emerging market stocks. The MSCI Emerging Market index represents
riskier, less developed countries but offers faster earnings growth. It has outperformed the S&P 500 Index
over the past 15 years, and we expect it to outperform the S&P 500 in the
long run going forward as well. However,
last year it lagged the S&P 500 by 16.3%.
More significantly, over the past 5 years, it has lagged the S&P 500
by 17.4% per year! Emerging Market
stocks also lagged the S&P 500 massively for 5 years ending in 1998 and
then outperformed significantly over the next 12 years. Offering materially better valuations at this
point, we consider emerging markets an attractive opportunity.
Unfortunately, valuations for most other equities (including REITs) are not
compelling now. Despite the much
discussed interest rate hike by the Fed, bond yields remain very low while money
market yields are still near zero. As
opportunities are few and risks remain elevated, we continue to emphasize broad
diversification, including allocations to truly diversifying investments such
as insurance linked securities.