Events often do not materialize when or even as expected. As 2015 began most market
prognosticators predicted positive returns for global stock markets of 5% to 10% or more. However, market indexes around the world closed out the year on a downbeat, which was particularly disappointing given the sharp rebound in stock prices we experienced this past fall. This left many U.S. investors with their first negative annual return from stocks since the current bull market began in March of 2009 — a result quite different from the one investors expected when the year began. As we shared with you last quarter, the year’s results forindividual stocks within the major indexes has varied considerably. In fact, the magnitude of this divergence just within the S&P 500 has rarely been wider, other than for few exceptions. One of the most notable occurred during the internet craze from 1998-2000. The 2015 market-darling FANG stocks (Facebook, Amazon, Netflix and Google) that investors clamored for posted an average gain of 83%!
A few examples of sector and industry performance for 2015 will further illustrate this:
- The Consumer Discretionary Sector was the best performing sector, increasing by 10%.
- The Energy Sector was the worst performing sector, declining by 21%.
- Within the Consumer Discretionary Sector, the Retail Industry increased over 20% thanks to Amazon. However, the Department and Specialty Stores subset of Retail declined more than 30%.
- Within the Industrial Sector, the Railroad, Truck and Construction Machinery industries each declined by more than 30%; while the Industrial Conglomerates increased 15%.
- For the usually-reliable Consumer Staples Sector, the Household Products industry disappointed investors by declining about 7%.
- In fact, on average, stocks declined 11% as measured by the Value Line Composite Index, an equal-weighted measurement of approximately 1700 stocks.
Source: Yardeni Research, Inc.
The 2015 returns for broadly diversified portfolios varied widely depending on investment philosophy, decision-making process, legacy holdings, and individual tax consequences. The performance for your stock portfolio was generally better than that of the average stock, but we are disappointed to report that it lagged somewhat the S&P 500 Index, the generally accepted benchmark for U.S. stock performance.
While evaluating our results for 2015 we found that many companies with global scale and diversified product lines struggled, while many of those with more focused market niches excelled. Companies that generated profitable returns on capital, and paid consistent and
growing dividends generally underperformed, along with companies with low debt levels and considerable amounts of cash on their balance sheets.
Although it is convenient to measure results by calendar years, we know that our investment horizon is much longer than one year, and hence our perspective on results should be as well. Over the past five years, the S&P 500 has appreciated over 80%, which equates to a compound annual return of 12.6%! This return is considerably higher than the 10% investors have come to expect over the long term, even though several unsettling market corrections and unexpected events occurred along the way.
These results were achieved because corporate earnings advanced steadily over the years. Recall that stock prices, over time, track the change in corporate earnings. In fact, individual stock returns as well as stock market returns are determined by a combination of three variables: (1) the growth in earnings, plus (2) the dividend yield, multiplied by (3) the change in the price-to-earnings ratio (or how investors value those earnings).
Given that 2016 began with a continuation of last year’s turbulent ending, investors are growing more concerned about the years ahead. And of course, there are some prognosticators predicting a negative year or two for stocks, and perhaps an end to the bull market. Let’s take a look at each variable to see what might happen.
Historically, when real global GDP growth is between 3-4%, the median S&P 500 earnings growth has been 6.1%. When real global GDP growth has slowed to 2-3%, earnings growth has been 2.8%. We expect earnings to grow modestly, even in a slow-growing economy.
The dividend yield for the S&P 500 is currently about 2%. And, many of the companies that Insight has invested in have dividend yields of 3% or more, with the financial strength to continue to safely grow their payouts.
The price-to-earnings ratio (P/E) is at a reasonable level of about 15 times 2016 expected earnings of the S&P 500, and much lower than that for many individual companies. Though the market’s P/E multiple could contract modestly from its current level due to growing negative sentiment, we don’t expect that this would materially drag down the total return earned from owning individual companies because of the positive contributions from their earnings growth and dividend yields.
We believe the concerns of the negative prognosticators, which may have some validity in the short-run, will prove to be overdone. We advocate taking a longer-term perspective, as the
U.S. economy has an underlying strength to it, and U.S. companies have the resiliency to adapt to the current global economic challenges. We believe stock investors should continue to be rewarded for their patience as long as they employ a sound investment process that includes an analysis of earnings growth, dividend yields and price-to-earnings ratios.
We wish you a healthy and prosperous 2016! INSIGHT INVESTMENT COUNSEL