We’ve closed the books on the financial markets for 2015, which means that it’s time to look back to see how the year turned out for investors before we move on to 2016. Basically, we need to know about 2015, in order to be able to profit in 2016.
That’s because much of what we experienced last year will affect how your portfolio will perform in the days and months to come.
The chart below reports the 2015 returns for the major asset classes impacting most investors.
From this chart, it’s obvious that 2015 was a very disappointing year, especially for those invested in stocks and gold. Bond investors fared a bit better because they were able to eke out marginally positive total returns as interest payments offset a slight erosion in the underlying principal value of their fixed income holdings.
Foreign stocks turned in negative returns with the emerging markets down by more than a whopping 16 percent… primarily because of the dependence of their commodity-driven economies on exports and a stronger dollar. The US continued to be the best house on a bad block, showing a slight positive total return of just over one percent for the year.
Gold continued to struggle, declining more than 10 percent in 2015…despite continued money printing and overt currency devaluation policies by the world’s central banks. I find this curious because gold has historically been viewed as a preferred alternative investment when there is easy global monetary policy.
And, there is no doubt that the world’s financial system is currently flush with liquidity.
So what’s going on?
It’s not great news, but the big headline is that we are in a slow-to-no-growth world. You can disregard anything else the mainstream media is saying about what’s driving returns, especially the lack of any positive momentum. It’s simply that growth is hard to come by. That’s all.
It’s because we are in a slow-to-no-growth world that stocks struggled to advance and oil prices collapsed in 2015.
And without growth, the world can’t make any meaningful economic progress, which means stocks will be facing a stiff head wind as they attempt to move forward from their current levels.
Let’s dig deeper and I’ll explain why and, more importantly, the actions you should be taking in your portfolio.
3 Factors Determine Stock Market Returns
In an article that I wrote last year, I introduced you to a simple, yet powerful and robust, 3-factor model that can be used to determine stock market returns. That’s right, there are just three factors that determine the returns for individual stocks and the overall stock market. These three factors are:
(1) Dividend yield
(2) Earnings growth rate
(3) Revaluation or change in P/E multiple
All three factors are expressed as a percentage. And all you have to do is add them together to find the total return.
Stock Market Returns in 2015
Let’s use our model to look at the total return earned from the US stock market for 2015.
Looking at this chart, it’s shocking that the largest component of stock returns for 2015 came from revaluation. This means that the reason that stocks were able to show a slight gain in 2015, was simply because investors were willing to pay more for a dollar of earnings at the end of 2015, than they were at the beginning of the year.
As a professional investor, that’s scary. Why do I say it’s scary?
That’s because it’s the experimental easy-money policies of the World’s Central Banks that are pushing investors into stocks (despite the lack of any underlying earnings growth) since the yield on other investments – primarily bonds — are so low.
What’s more, investors’ moods can swing dramatically; and the current overriding mood is one of quiet complacency.
But when sentiments do change from smugness to fear, then the revaluation component for stocks will flip-flop, causing this element of stock market returns to turn negative and stock prices to erode quickly.
We saw that happen in September of last year and I expect that we’ll see more severe mood swings in 2016.
In this environment, what should an investor do?
To earn enduring profits in a slow-growth world and to hedge yourself from changes in investor temperament, you should focus on the two sustainable components of stock returns: dividends and growth. These are the essential elements that will propel your portfolio higher over time and provide the ultimate hedge to protect your nest egg in times of fear.
That’s why a carefully selected group of growth stocks should form the core of your portfolio.
Companies with high earnings growth rates, such as Amazon (up 117 percent in 2015), Facebook (up 34 percent in 2015), Netflix (134.38 percent in 2015), Google (up 46.6 percent in 2015), Visa (up 19 percent in 2015) and Nike (up 31 percent in 2015) when purchased at the right price can provide a real boost to your portfolio. Investors that prefer exchange traded funds should consider the iShares Morningstar Large-Cap Growth ETF (JKE) and even the high flying Power Shares QQQ Trust ETF (QQQ).
You’ll need to do your homework, be selective and buy at the right price so you feel comfortable holding your positions, and perhaps adding to them, when the market dips or even falls substantially.
Legend has it that Albert Einstein once said compounded savings was the greatest invention in human history. Regardless of whether Einstein actually made the observation or not, financial compounding has made investment icon Warren Buffett one of the wealthiest people in the world.
In fact, Charlie Munger, Warren Buffett’s longtime investment partner, has repeatedly said: “Understanding the power of compounding and the difficulty in achieving it is the heart and soul of understanding a lot of things.”
And of one those things, is the potential to watch your portfolio soar, while other investments are languishing in a slow-to-no-growth world.
Keep an eye out for a future article where I’ll reveal to you how the Fed’s and the ECB’s current monetary policy are similar to a legendary gambling strategy and what that means for future investment returns.
Until then, I wish you all the best in your pursuit of profits.
Bill is President and Senior Managing Director at Plimsoll Market Capital, a national wealth management firm that provides financial, tax, and investment advice to wealthy families. In 2012 he published his first book “Changing the Game: How to Profit From Your Passion for Sports“.