How to watch the market

Most investors have been caught by surprise by the volatile start to 2016. The strong performance of a few stocks over the last 12 months has masked overall weakness that has persisted in the stock markets. The larger S&P 1500 and the S&P 600 Small Cap Index are both down more than 20 percent from their 52-week highs.

What is interesting about the current pullback is that it is divorced from fundamentals. While the U.S. is clearly in a manufacturing recession, other data doesn’t suggest reason to panic – outside of energy.

Just like we experienced in 2015, global stock markets are likely to be driven more by drama than data.

What to Watch for in 2016

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  • Economic growth or recession? History shows that economists’ consensus forecasts do not foresee a recession until it hits. But they provide a useful base case for your planning. Most professional economists remain sanguine about the U.S. economy in 2016. At the most recent meeting of the Fed Open Market Committee on Dec. 16, its members expected real GDP to grow 2.6 percent this year. The Fed’s survey of professional forecasters on Nov. 13 had the same prediction, and saw a roughly 13 percent chance of a downturn in Q1, Q2 or Q3. Business cycles don’t suddenly occur or die for no reason. The last 15 recessions have all been triggered by something that robbed consumers of their jobs and their spending power. In 2016, the U.S. worker may look vulnerable. Yet wages have been rising, and cost-of-living increases appear negligible.

  • Oil. Stability in oil prices even at low current levels would be a positive for the financial markets. The key point to watch for will be the peak in inventories. Two factors that could lead to oil upside before the peak would be a change in Saudi Arabia’s strategy to subordinate price to market share, or a clear indication of the expected 2016 U.S. production decline.

  • U.S. interest rates and Central Bank policy. The Fed raised short-term interest rates for the first time since 2006 this past December. Even though it is a sign of economic strength, it spooks investors. Market expectations for future Fed rate hikes have been slowly converging toward a more patient approach to rate increases.
  • China. The recent moderation of growth in China is an inevitable normalization for an economy of its size; its nominal level of gross domestic product is now five times the size of what it was 10 years ago. Nevertheless, the uneven economic data points amidst an overall deceleration in growth for China are likely to contribute to volatility in 2016.

    Action Plan

  • Don’t try to time the market. Depending on which study you look at, individual investors seem to sacrifice more than 2 percent of annual returns (and often much more) by trying to time the market. There are numerous “systematic” ways to avoid this sort of emotionally driven fear – dollar-cost averaging, holding some cash or short-term bonds and rebalancing on a quarterly or annual basis.
  • Be patient and systematic. You should use this period of volatility to assess your current portfolio allocation strategy. Ensure that your risk profile is aligned with your asset allocation. In the last 45 years a globally allocated 60/40 stock/bond portfolio has never had a negative rolling five-year return.
  • Tax-loss harvesting. One of the few benefits of down markets is to improve your tax-liability situation. Tax-loss harvesting involves selling a security that has lost value in your portfolio and buying a similar security. By disposing of the asset at a loss, also known as harvesting, you may be able to offset capital gains taxes. •

    Matthew M. Neyland is director of investments for SK Wealth Management.

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