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Fourth Quarter 2015 Investment Report

Cheap and Popular

First Lady Kim Kardashian West. It has a nice ring to it, don’t you think?  A few months ago, Kim’s husband Kanye West -- a rapper, record producer and clothing designer, announced that he would be running for U.S. President in 2020.  Before you snicker, don’t forget about a current poll-leading, ultra-wealthy Republican candidate with huge ego and no political experience. 

Back to Kim. Her popularity was immense even before her third marriage and two children, before her $200 million video game smart phone app and her fashion magazine covers, and before her family’s reality TV show and retail stores.  Her fame started when her bombastically-enhanced hourglass figure was viewed in an erotic rendezvous that was “leaked” onto the internet over a decade ago.  Add a very suggestive wardrobe to the mix and you have that perfect combo – cheap and popular. 

In a somewhat different vein, cheap and popular is also a prevalent concept in economics. All things equal, there is more demand for goods or services at a discount than at full price.  That’s why Black Friday’s retail sales set records. 

Somehow, this very basic proposition is turned on its head when we review the stock market. In line with other goods and services, one might expect that every time the share price of a publically traded company decreased, more buyers would appear to take advantage of the “sale.”  But we know that is not what happens.  In fact, usually the reverse occurs.  When the price of a stock, industry sector, asset class or even entire market dips below accepted limits, the result is usually a panic, when investors do their best imitation of lemmings fleeing the scene.  This reaction is why a bull market is often described as an up escalator, while a bear market is described as a down elevator.

Even more puzzling is the actual value proposition involved. Most goods, like a car for instance, are worth less and less as time marches on.  Not so with stock ownership.  Over longer-term  periods (five to ten years and beyond), most economies expand, and the price of a public company’s common stock usually expands as well.   This is due to increased earnings and potential dividends.  Why would an appreciating asset (stock) be treated so much differently than a depreciating one (car, computer, socks)? 

The astute observer may correctly answer that a company can go out of business and its stock become worthless.   Enron, WorldCom and Lehman Brothers all went to zero, and stayed there.  This risk is valid.  Any single company can indeed go bankrupt, proving that it was not a bargain to buy at ever lower prices.  That is precisely why DHG Wealth Advisors uses asset class investments and not individual securities.  Owning asset classes allows our clients to own hundreds or thousands of similar companies in each asset class fund held in their portfolio, thereby eliminating any risk of any particular company’s bankruptcy.    We don’t have to worry about buying a stock that may never bounce back. Rather, we know that all asset classes will bounce back at some point in the future.  Buying them at much lower prices, in order to bring the portfolio back to its originally intended asset class weightings, will prove to be an astute behavior when the market cycle ultimately reverses and equities resume their long term upwards direction.  This amounts to a built-in buy low, sell high mechanism, without ever having to “guess” the correct time to make those transactions.  

No, it may not be as sexy as Kim or her sisters, or finding the next Wall Street highflying tech or pharma darling. But if long term performance is your goal, this approach is a proven winner.  We absolutely know that buying an asset class cheaply will be a popular decision at a later date, and this cheap and popular methodology will insure a competitive long term portfolio return -- regardless of who’s the First Lady after the 2020 Election.

 

Fourth Quarter and Full Year 2015 Asset Class Returns

 

2015 – The Year That Nothing Worked

In the fourth quarter, all equity asset classes, other than Emerging Markets, bounced back from the big losses experienced in the third quarter. But this bounce was not big enough to allow most asset classes to experience a yearly gain.  It was a very unique 12 months, not due to any incredibly great or poor performances, but because there were very few asset classes that allowed one to increase, or even preserve, capital.

A properly diversified equity portfolio would have guaranteed a negative return, because all asset classes other than Large Core (S&P 500), Real Estate and International Small Caps had negative returns ranging from modest single digits to high teens. But the red ink did not stop there.  Precious Metals, Energy, High Yield Bonds, Hedge Funds and Commodities were all losers.  In fact, Bloomberg announced that it was the worst year for asset allocation funds since 1937.*  They follow 35 different Exchange Traded Funds (ETF’s) that specialize in risk diversifying asset allocation strategies, and the average had a median loss of 5% or more. *Bloomberg.com 12/28/15

So, just what is going on here? Many unique things occurred in 2015 that caused this situation to occur.  Let’s list a few of them:

  • The slow growth, or downright stagnation of many global economies, continued to act as a wall of worry, led by the 800 lb. gorilla China. Its potential sub 7% economic growth rate radiates fear to every global marketplace.
  • Energy hit 11 year lows, which is great for drivers, but crushing for all energy related companies. This fact was solely related to a couple of S&P 500 quarterly earnings being in the red.  The US economy without energy is doing fine.
  • Diverging monetary policies between the US and Europe. European Union countries are still lowering their interest rates in an attempt to stoke some life into their fragile economies.  They appear to lag the US economic recovery by 18-24 months.  
  • The Federal Reserve finally decides to raise the discount rate for the first time in 9 years. After innumerable chances, the Fed raised the rate in December, and now the markets fear how high and how fast the rates will rise.
  • ISIS is continuing their barbaric actions, which are psychologically affecting both citizens and markets – both abroad and at home.
  • The US Presidential primary race is in full gear. Many cannot believe that Donald Trump still has a commanding lead for the Republican nomination, and Hillary & Bill are starting to focus on this leading contender.  International relations, military strength, domestic economic policy and potential major tax law changes are just a few of the subjects that will keep us entertained as we choose candidates this summer and experience a very meaningful election this fall. 
  • Lastly, prior to 2015, equity markets had six straight years of positive returns. It is only natural for some type of consolidation, either by a meaningful pullback or lengthy sideways correction, or both. 

Many of these issues will continue to be headliners in 2016. We can only expect that the increased market volatility in 2015 will continue in the New Year.  None of this changes how your portfolios will be managed.  Your long term goals demand a disciplined approach, and the turbulence of the markets is something that is expected and normal, especially when comparing it to market movements over that last 30 years. 

We should be able to learn more about several of these issues in the first quarter of the year. While we are waiting, enjoy your winter season, stay warm and keep your sense of humor.  That always helps during election years!

Sincerely,

Frederick F. Kramer IV, JD

Chief Investment Officer