It’s difficult to believe that 2016 is almost here. It truly feels like it was only yesterday that we were joyously ringing in 2015.
2016, a Presidential Election year, promises to be one full of opportunities for the informed and savvy stock market investor.
Understanding these three known macro themes for 2016 will provide you a framework from which to base investment decisions.
This article will take a closer look at each of the three macro themes and provide a specific stock pick for each of these market effecting subjects.
First, a quick look back at 2015 to frame our view into 2016.
2015 will be forever remembered in market lore as the year the Fed finally raised interest rates. The economy has improved to the point of no longer needing the incubator of near zero rates and the hand of Mother Fed to feed it.
Despite the major stock market indexes closing near breakeven for the year, several very notable economic events rocked the markets.
The most shocking event for investors happened in August.
On August 24, the Dow Jones Industrials Average experienced its largest plunge in four years. The flagship index gave back over 1,000 points at the open to eventually close lower by 588 points on the session.
Representing the index’s eighth largest points fall ever, it clearly revealed the interconnectedness of the global economy.
The trigger was the mounting concern over China – Shanghai stocks tumbled nearly 9 percent that day. Within the next week, the Dow fell over 10 percent.
Other international events that pressured the U.S. markets in 2015 include the Greek economic crisis, currency collapses in Brazil, South Africa and Turkey, as well as negative European yields.
Just the fact that the U.S. stock market did not dramatically plunge in the face of these tremendously bearish headwinds is a testament to its deep rooted strength.
The end of the bull run or did it merely take a break?
The S&P 500’s bull launched 81 months ago and has advanced 200% from its March 2009 low.
Representing the third longest lived uptrend since 1932, it has crushed the average bull market gain of 138%, according to UBS. Julian Emanuel, a strategist at UBS and his colleagues, wrote in a “U.S. Outlook 2016” report this week:
The S&P 500 will end 2016 at 2,275 amid modest earnings growth and rising interest rates. That level translates to $227.50 for the SPDR S&P 500 ETF (SPY) — up 11% from Thursday’s close.
“Though skeptics could point to the extent of gains, as well as the length of the rally since 2009, as sufficient rationale to believe a bear market is ‘due,’ we highlight that although the current rally is extended in both time and price, it is only the third longest and fifth largest rally since the Great Depression,” UBS added.
The analysts went on to say, “That said, no bull market since before the 1970s has ended without a recession and both our U.S. economics team and our U.S. credit strategy team do not forecast a near term recession. Simply put, barring an unforeseen external shock or a recession, if earnings continue to improve, 2016 should be a positive year for U.S. equities. Regardless, we continue to expect further volatility – which, in essence, means higher risk, both upside and downside.”
While this is just one institution’s opinion, it fits our outlook based on the:
The 3 Main Market Moving Themes for 2016
- The Presidential Election
The one thing that history tells us is that the stock market generally becomes more volatile during Presidential election years.
The S&P 500 has fallen only 3 times since 1928 during an election year.
However, when it does, it falls hard!
The election year of 2008 is a case in point, when the S&P 500 collapsed over 30%.
Interestingly, the stock market does not care if a Republican or Democrat wins the election.
Election year volatility is due to uncertainty. Stocks hate uncertainty, even if it`s over something that doesn’t matter in the long run.
Common sense would seem to dictate that the stock market should perform better under a Republican President than a Democratic one.
This is due to the lower taxes, pro business rhetoric of the Republicans and the supposed anti business, high tax stance of the Democrats. However, like most `common sense` things about the stock market, it simply isn`t true.
The truth is that stocks have performed better, on average, during Democratic administrations than Republicans ones. While this flies in the face of conventional wisdom, the statistics don`t lie.
The average annualized returns for Bush 1, Eisenhower, Bush2, Reagan, Ford, Hoover and Nixon is 0.4%. Take out the 30% decline under Hoover as an outlier and the average return is 4.7%.
On the other side, the average annualized return under the Democratic administrations of Clinton, Truman, Johnson, Roosevelt, Carter and Kennedy was 8.9%.
According to S&P Capital IQ, small cap stocks outperform the overall market during Presidential election years. The firm studied returns since 1980 concluding, “In Presidential election years since 1980, small caps have risen on average 10.9%, more than double the 4.2% gain for the S&P 500.”
Following this theme, we like the Schwab US Small-Cap ETF (NYSE:SCHA) for 2016.
More aggressive traders may want to look to a VIX ETF such as the S&P 500 VIX Short-Term Futures ETN (NYSE:VXX).
- Climbing Interest Rates
Like most things stock market related, the anticipation is far worse than the actual occurrence. In other words, the fear of climbing rates seems to have more actual effect on stocks than the actual process.
Now that the slow process of rate increases has started, my bet is that it will have very little actual impact on the overall stock market. However, there will be certain sectors that will benefit from higher rates.
One of these sectors is the banking sector. As rates climb it enables banks to charge more interest, which in turn, lifts the bottom line.
We like Bank of America (NYSE:BAC) and more aggressive traders can try JP Morgan ( NYSE:JPM) as another beneficiary of the same theme.
In addition, any of the smaller financial lending firms should benefit from the climbing interest rates. I also like the regional banks in this regard.
- Central Bank Strategy Dislocation
Generally, central banks from the leading economies are on the same page when it comes to strategy.
Today, there is dislocation between the different economic strategies. The United States has started the regime of interest rate increases while other nations are lowering rates.
In fact, some rates are going below zero in the Eurozone. This means that the euro currency should continue to weaken against the greenback.
Shorting the euro via the PowerShares Short euro ETF (NYSE:EUFX) makes sense in a sub zero interest rate regime. Traders can also benefit from the dislocation by going long ETF’s representing the greenback.
Always remember that there will be surprises in 2016. These three primary themes are to be taken as a framework only. Anything can and may happen in the stock market! It is best to be cautious but not afraid to take positions based on the best of your knowledge at the time. All investing involves risk, those who embrace risk are the winners of the game.