The Long and Winding Road (To Nowhere)


What happened to the bull market?

For the last 18 months, investors have been on a long and winding road with little or no return to show for it.  As the chart above illustrates, domestic equities and real estate have led with modest returns, but each have experienced significant volatility.  As you diversify further, your return would have suffered with commodities and emerging market equities as the biggest laggards.

Take particular note of the NYSE Composite Index and its performance during the referenced period.  This index includes over 1,900 stocks and, in my opinion, its breadth makes it a better indicator of market performance than the more commonly-used narrow indices that contain fewer components.  The index is down over 9% since July 22, 2014 and its performance will probably look very similar to the equity allocation of most properly diversified portfolios.  This may be a frustrating realization for many investors when they see that the S&P indices are relatively flat during that same time period.  These returns, however, are deceiving...

The graphic above represents the current holdings of the S&P 500 Index, categorized by sectors and industries, with year-to-date performance included.  Most importantly, the size of each position in the graphic represents its weighting within the index.  As you can see, a majority of the returns for the index come from a relatively small number of mostly tech-related stocks.  In 2015, the so-called "FANG" trade was popular and successful, with Facebook, Amazon, Netflix and Google producing returns in excess of 35%, 113%, 138% and 44%, respectively.  These strong but sparse returns have bolstered the index performance and distracted from the underlying deterioration.  At present, only 43% of the S&P 500 stocks and 28% of NYSE stocks are in an uptrend.

Where do we go from here?

In spite of the stagnant returns, and the fact that most investor portfolios have been void of meaningful growth for over a year and a half, we are still in a bull market from a technical standpoint.  And, as you can see in the chart above, the current bull market may soon become the second longest bull market in recorded history, elongated by extraordinary monetary policy.  This presents an interesting backdrop as we look for opportunities entering 2016.  

We enter 2016 just as the Federal Reserve has decided to begin raising interest rates unusually late in the market cycle and following the 4th quarter in a row decline in quarter-over-prior-year quarterly operating earnings.  In spite of this, as Don Schreiber, Jr. of WBI Investments writes, "equity prices remain elevated with the S&P 500 Index trading at a P/E of 20 times trailing earnings.  In our review of historical measures, it seems this high P/E is counterintuitive against a backdrop of falling earnings, falling corporate revenue, weakening economic performance, and a potential monetary policy reversal that removes the Fed’s backstop to asset prices."*

Not surprisingly, we enter the new year in a defensive position with a sizable cash allocation in most portfolios.  For many of the reasons stated above, it has become increasingly difficult to find "value" at current levels.  With that said, and the obvious frustrations of a sideways market aside, it's important to remember that it is not uncommon to experience periods of low growth during a bull market cycle.  Remember, earnings matter again.  And if we see improvement in the underlying earnings, there is no reason why this bull market can't continue.  

Source: Don Schreiber, Jr. "Stop 'QE' Insanity" WBI Investments . 13.11.2015

*Investing involves risk including the potential loss of principal. No investment strategy can guarantee a profit or protect against loss. Past performance is not a guarantee of future results. This material is for informational purposes only and is not a recommendation, offer or solicitation to buy or sell any specific security. The S&P 500 (Standard & Poor’s Stock Index) is a stock market index containing the stocks of 500 American corporations with large market capitalization that are considered to be widely held. The S&P 500 is unmanaged and cannot be invested in directly. The New York Stock Exchange (NYSE) is considered the largest equities-based exchange in the world based on total market capitalization of its listed securities.