The New Year is a time for looking back and forward, a time for reflections and resolutions. In the investment world, it’s helpful to understand what has happened. At the same time, people want to know what will happen. While we are not prognosticators, we do our best to provide insights and prudent observations.
The U.S. stock market reached an all-time high in May 2015, but declined over the summer as concerns about a slowing economy in China reduced stock prices. From the peak in May to the trough in August stock prices declined -12%. This was the first decline of -10% or more in four years. At year-end, the stock market, as measured by the S&P 500 Index, was up a little more than 1% and the bond market delivered a total return of less than 1% (per Barclays U.S. Aggregate Bond Index). Previous market darlings like emerging markets were down more than -10% last year. One of the S&P 500’s worst areas was energy and commodity stocks. The largest energy ETF (exchange traded fund), Energy Select Sector SPDR Fund, was down more than -20% for the year (for details on the commodity cycle decline and its impact, please read Andrew Boord’s commentary).
The most prominent topic is the pace of worldwide growth. Since the middle of last year, the primary question for investors has been the Chinese economy’s rate of growth. This is an important consideration as China is a large source of demand for many commodities and industrial products. For example, when China slows building construction, the need for iron ore wanes and there are fewer orders for industrial companies down the supply chain. Therefore, in the short term, as China goes so goes the world economy to some degree. In America, we anticipate continued slow growth with low interest rates, low energy prices, and modest job creation. We don’t expect anything outstanding.
Whether it’s commodity prices, China’s economic slowdown, currency headwinds, or unforeseen factors around the bend, there are always uncertainties. That is why we have remained steadfast, for decades, that the best way to grow wealth for you is to invest in a select number of high-quality businesses at bargain prices that have the potential to grow over the long term and outpace inflation — despite short-term market conditions.
Overall, high-quality companies tended to outperform low-quality companies in 2015, especially those exposed to commodities and with “stretched” balance sheets. For 2016, although we are not certain where the economy and stock market are headed (and be leery of anyone who tells you they do know), our experience gives us confidence that financially strong, well-managed businesses should prevail over the long term. Please remember that we define risk as permanent loss of capital, not stock market volatility. For bargain hunters like us, volatility creates entry points. It’s our experience that the share price paid for a stock makes a big difference for long-term returns. That is why we try to take advantage of market downturns and invest in high quality businesses at a discount to our estimation of their economic worth.
Although we can never know what the future holds, there is one certainty — we resolve to adhere to our value investing strategy as we seek to protect your assets and grow them over the long term.