Prediction-Free 2016 Outlook

Prediction-Free 2016 Outlook

After rereading my January 2014 outlook, I am not surprised that this year's will be remarkably similar. Energy stocks were the worst performer in 2014, and anyone who went bargain hunting thinking $60 a barrel would be the low got banged up again in 2015. Lesser-quality bond spreads were widening, and that trend continued this year. Certainly the geopolitical concerns we cited have not waned.

On the positive side, the Fed finally hiked rates and the world hasn't ended. The global economic slowdown, especially in China, so far has only manifested itself in lower-commodity prices. Equity prices have been remarkably stable. Expensive markets can correct themselves either by price or time. A year or two (or three) at relatively unchanged prices allows earnings and valuations to "catch up" to prices before moving higher again. Perhaps that is what is happening now.

That said, stocks remain expensive by any fundamental measure, perhaps more so than last year because earnings have gone down while prices have remained stable. At just under 20 time forward earnings, the current P/E ratio is higher than 82 percent of all daily readings since 1929. In terms of book value, the index is currently trading at 2.75 times its most recent book value of $733.84. Since 1978, the average P/B ratio has been 2.44. The dividend yield of the S&P 500 is currently 92 percent of the yield on the 10-year Treasury, which is below the historical average ratio of 110 percent.

None of these measurements are trading tools that imply if they hit a certain level, you have to get out. This coming year will be the third one in a row that these measurements are above historical levels, yet prices have continued to move higher. Instead, these are risk-management tools. If you are nearing a life event like retirement, or will have a need for capital within the next few years, taking something off the table can be a prudent thing to do.

What made 2015 a tougher investing year than indicated by the averages is that having a diversified portfolio did not really add any value. In fact, it was only the second time in 20 years that at least one of the four major asset classes (U.S. stocks, bonds, foreign stocks, and commodities) didn't finish at least 10 percent higher. So if you had any allocation to MLP's, or small-cap stocks, for example, you didn't have an investment in another asset class to make up the difference.

That does not mean diversification doesn't work anymore. It does mean you have to know your own risk tolerance, and also know what risk is in your portfolio.

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