4th Quarter 2015 Commentary

The New Year Upon Us……..

With the “rough waters” of 2015 behind us, investors must now look to 2016 and how to navigate the crosscurrents of world politics and economics – some of which are apparent and some sure to surprise as the New Year unfolds.  Apparent are low energy prices around the globe; interest rates in the United States on the rise and most everywhere else rates on the decline; a Middle East embroiled in at least two wars (Syria and Yemen); Europe being overwhelmed by a flood of émigrés from the Middle East; OPEC suffering from discord and national budgets of all members hemorrhaging badly from social and defense commitments; China still growing faster than most any other major country (except for India) but slower than people are used to; India growing faster than any other major country; Russia still playing a political “spoiler’s game” around the world; Europe continuing to be mired economically in a bog of anemic growth; an upcoming Presidential election in the U.S.; terrorist attacks in the Euro zone which will stir nationalist political feelings; Brazil trying to cope with a Presidential impeachment; Puerto Rico trying to survive fiscally; the American economy still powering ahead steadily; the American consumer bolstered by low unemployment and low inflation; a strong U.S. dollar; low industrial and agricultural commodity prices and volatile financial markets.  This is all “quite a stew” to which could be added other ingredients of confusion – but we think these are “the headliners” which will influence market action in the coming year in addition to some not so apparent events which will affect outcomes.

So let’s spend some time examining some of “the headliners” to try to make some sense of the “stew”.  Low energy prices are unabashedly good for the world as the vast majority of the world is a consumer of energy, not a producer of energy.  We have found it curious in 2015 that the correlation between oil prices and stock prices in the U.S. has risen.  As oil goes down so too have stock prices and vice versa.  This makes no sense to us. We think it should be that as oil prices go down the financial markets (ex. the energy names obviously) should go up.  The correlation should be low because higher energy prices are bad for the world’s economies and low energy prices are good.  The only possible explanation for this curious correlation is that investors are equating low commodity (i.e. oil, iron ore, nickel, lead, tin, wheat, corn, etc.) prices with a low demand recessionary environment.  This is not what is happening today. Demand across the board for commodities is pretty strong and increasing, but not at the same rate as supply. Producers have brought too much capacity online and are suffering the consequences of low prices.  As supply gets cut, prices will rise. So financial markets should be supported by low energy prices, even if prices rise because we are well off the highs (remember $114/bbl??). In fact, there are many around the world who would like to see some price relief – from North Dakota to Moscow – and we think some relief should be apparent in 2016.  Production has been cut due to low prices.  Demand has been increasing. Americans drove more miles in 2015 than in 2014 and purchased bigger, less fuel efficient vehicles in 2015.

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More people in China and India are driving.  New chemical plants are being constructed in America and the U.S. is beginning to export natural gas and oil to the world thanks to recent legislative changes.  More energy is being consumed and less of it is being produced. Price should rise sometime.  Also the American consumer will hopefully open their pocketbooks a little bit wider.  It was expected that with energy taking a smaller bite of the consumer’s wallet, more would be spent elsewhere.  Indeed, the U.S. consumer has been spending on vehicles and housing (i.e. big ticket items) but other retail outlets (clothing in particular) have not yet benefited.  Savings have increased.  Perhaps now after a year of feeding the “piggy bank” more spending will occur.

Interest rates in the U.S. are on the rise – elsewhere in the world this is not the case.  Importantly, we do not believe that the trajectory of interest rate increases in America will be steep in 2016.  We believe Fed Chair Yellen and we take her at her word.  So by year end 2016, while interest rates in the U.S. may be higher than today, they still will not be high as compared to even an historical ”normal”.  The financing environment will remain pretty relaxed –money will be pretty cheap throughout 2016.  Mergers and acquisitions should have another good year, especially in the oil & gas industry, which we predict will see a wave of consolidation.  A result of relatively higher interest rates in the U.S. should be a relatively stronger currency.  So one should expect the dollar to remain strong in the coming year.  This could be a “drag” on foreign earnings for U.S. based companies, as it was in 2015.  We think however most of the “drag” was in 2015.

Problems continue to fester in the Middle East. It is a “tar pit” – even from afar.  With wars raging and people fleeing, the social structures of Europe are being mightily tested.  Terrorist attacks will continue to challenge feelings of good will.  Nationalism in various countries taking various forms will continue to rise.  This burden will not help Eurozone markets in the near term.

China looks to continue its march of growth.  In 2015, China imported more oil and iron ore and set records for both products. But China is also in the midst of change from an industrially oriented economy to a service based economy.  Growth in the future will focus on education, healthcare, leisure, retirement planning and not on the construction of new steel mills.  In India, think China twenty years ago, the opportunity set is even broader than in China.  The economy now is smaller than China’s and less developed.  The population is younger.  Industry is being developed with a cheap labor pool. But the service economy (e.g. information technology) is developing rapidly.  India in 2015 grew faster than China and is slated to do so going forward with what will become the largest population in the world in the relatively near future.

So while the two biggest emerging economies apparently have pretty bright immediate futures, this is not the case in Brazil. Despite the upcoming economic boost of hosting an Olympic Games in 2016, the country is caught in a political maelstrom – the impeachment of its President and reports of massive fraud connected to Petrobras, the country’s national oil company.  The markets hope for a change in leadership.  If the right changes occur, the Brazilian market should be one of the top performers in 2016.

American politics will “rule the airwaves” throughout 2016 as the U.S. elects a new President. Historically, a Presidential election year has been a good one for the markets (especially when Republicans control Congress, curiously enough) as a lot of money gets spent to elect some candidate and the incumbent President and Congress attempt to gild the economy.  No doubt, a lot of money will be spent this year on the many political races – which should provide a nice fillip to the American economy and some American companies.

Corporate earnings estimates started 2015 on a high note; as the year progressed, the estimates came down.  Most often cited by company managements as reasons for the shortfall from expectations were dollar strength (bad for overseas sales and earnings when translated back into dollars) and low oil prices (i.e. the energy industry had their earnings gutted).  Taken together, these two were most responsible for the flat earnings for the S&P 500.  As 2016 starts, analysts are much more circumspect compared to last year at this time– expecting little growth (3% to 7%) in U.S. corporate earnings over the coming year.  If the dollar were to stabilize and if energy prices rebound from their current low levels, S&P 500 company earnings would surprise analysts to the upside, which could spark a stock market rally.

Bull markets do not die of “old age”.  If there were a looming recession it could kill a “bull,” but as the following chart shows, there is scant evidence of a recession on the horizon.

U.S. Recession Risk Indicators
Data Through Latest Reading Recession Signal
1 Average Hourly Earnings (3 Month Average Y/Y%) Nov 2.40% NO
2 PCE Deflator (12 Month Average Y/Y %) Oct 0.40% NO
3 CPI Energy (12 Month Average Y/Y %) Oct -15.70% NO
4 Nonfin Unit Labor Costs (4Qtr. Average Y/Y%) 2015:3Q 0.06% NO
5 Residential Construction% Nominal GDP 2015:3Q 3.40% NO
6 Total Investment % Nominal GDP 2015:3Q 16.20% No
7 Output Gap % Potential GDP 2015:2Q -1.90% NO
8 Domestic Corporate Profits Fin & Nonfin % Nominal GDP 2015:3Q 9.30% NO
9 10-Year Treasury & 3-Month T-Bill spread (3 Mo. Avg.) Nov 212 BP NO
10 Global Short Rates (12 month Average Y/Y Change) Nov -4BP NO
11 Consumer Non-Mtg Delinquency Rate (ABA) 2015:2Q 1.36% NO
12 Baa Spread Nov 320BP YES
13 U.S. Real Trade-Weighted Dollar (2 Year % Ch.) Nov 16.50% YES


So let us consider that the lackluster market performance of 2015 was a “pause that refreshes” and let’s look forward to better times in 2016.


1) U.S. Housing should expand & support the economy.
Yes – Housing was a major support for the U.S. economy.

2) U.S. employment will improve throughout the year.
Yes – Unemployment in America reached a new low for the recovery.

3) Companies will raise dividends & buyback stock
Yes – Companies “across the board” raised dividends and bought back stock.

4) The Fed will keep interest rates lower for longer
Yes – Much to the surprise for many pundits, the Fed delayed raising & raise them slowly & not sharply late in 2015 rates until its last meeting of the year in December.

5) The U.S., India, Japan, Brazil & Indonesia will accelerate their economic growth.  China will not. Europe will try but try not succeed.
Yes & No – India’s growth rate did accelerate. The U.S., Europe and Japan posted rates of growth similar to the year before. Brazil and Indonesia       slowed. China slowed as expected.

6) Politics in the Eurozone will spark some “fireworks” which will add volatility to markets.
Yes & No –There were some political fireworks as anti-austerity did gain influence, but no particular market reaction to the results.

7) The dollar will be strong.
Yes – In anticipation of higher interest rates, dealers strongly bid the dollar throughout 2015.

8) The euro & yen will be weak vs the dollar.
Yes – With the European Central Bank and the Bank of Japan promoting easy monetary policies to stimulate their respective economies; the euro & the yen were weak against the dollar.

9) A political solution to the Ukraine issue will be found.
No – Got this wrong. No solution yet and the issue is “on a backburner” after Syria now.

10)  The price of oil will start its rally in late 2015.
No – Got this wrong.  Believe that the turn in price has been delayed until 2016.

PREDICTIONS FOR 2016                      

  • Economic growth will continue at a pace of around 2.5% – 3%
  • Inflation will remain quiescent
  • The dollar will stabilize, perhaps strengthen a bit more
  • During 2016, oil’s price will find a bottom not far away from now and will rally into 2017
  • Interest rates will rise – but the rate of increase will be slow
  • Political reform will grow in South America
  • It will be another “Banner Year” for mergers and acquisitions
  • Consumer spending will improve
  • Émigrés will continue to be a “hot potato” politically around the world
  • Amongst the popular investment alternatives, equities should do the best


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The opinions expressed in this Commentary are those of Baldwin Investment Management, LLC.  These views are subject to change at any time based on market and other conditions, and no forecasts can be guaranteed.

The reported numbers enclosed are derived from sources believed to be reliable.  However, we cannot guarantee their accuracy.  Past performance does not guarantee future results.

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