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Market Commentary 12/31/2015

Back to the Future

This past year marked the thirtieth anniversary of the Michael J Fox movie, Back to the Future. The characters in the film use a DeLorean sports car as a time machine to go into the past to change the future. As financial planners and investors, we wish it were this easy. If it were, we wouldn’t go through the process of diversifying a portfolio; we’d simply pick the top performing stock. We would be able to perfectly model how much clients need to save early on and we would only insure against events that we knew would happen. Unfortunately we can’t know the future. However, we do think there are important lessons we can learn by looking at the past so before we review the most recent quarter and outlook for investors, we’re going to travel back in time.

Back when Marty and Doc Brown were beginning their time travel experiment, the US economy was just returning to solid footing after a deep recession that gripped the US. Little did anyone know at that time that markets were in the very early stages of the greatest bull market in a hundred years. During the 1970s and early ‘80s, many had grown weary of the investment markets. The US had an energy crisis, unemployment was high and inflation was staggering. The economy was moving so slowly that the combination of high inflation and stagnant growth was coined “stagflation.”  Even the high rates earned on bonds and bank accounts were offset by the high inflation levels and double digit financing costs of mortgages and other loans. Investors had little to get excited about.

We can now look at that period as ‘lost.’  The S&P 500 essentially ended where it started with a lot of ups and downs along the way. However ‘lost’ is a relative term. During the period from 1970 to 1979 investors saw an average annual return of 5.9%. This was what investors received on average after reinvested dividends and capital growth. It was still a far cry from the double digit returns averaged over the prior 20 years, and investors expecting consistent double digits were disappointed. Even as the market exited the recession and was on its journey upward, there was always something to worry about. Naysayers continually called for market collapses, the Cold War was still going, wars were being waged in the Middle East and a Savings and Loan crisis threatened a large part of our country’s financial sector. Ultimately, though, the modest returns of the ‘70s set the stage for the tremendous returns that were the ‘80s and ‘90s.

Fast forward to 2015. Even though the year ended with volatility and a lot of things to be concerned about, returns for the quarter were respectable. The large US companies in the S&P 500 generated a positive return of 7% and medium and small size US company sectors were both up 3.6%. For the year, returns reflected the global concerns of a Chinese slowdown and the European debt crisis. The S&P 500 eked out a positive 1.4% in 2015 while the smaller companies did not fare as well. Medium size companies were down 2.4% and small companies lost 4.4%. International markets that should have held so much promise had dollar-denominated investor returns wiped out due to a rising US currency. The broad international markets as measured by the MSCI EAFE lost 0.4% for US investors. The emerging markets were hit particularly hard as they were impacted by the slowing Chinese economy. Emerging markets lost 14.6% in dollar-denominated returns.

When we look at the world and the markets, there doesn’t appear to be much to cheer about in 2016. US equities are now nearly 7 years off their 2009 lows and stock prices have moved at a much faster pace than the underlying earnings. This makes valuations for the broad market stocks relatively expensive, bringing out the naysayers in full force. However the volatile markets have also created new opportunities. We’ve seen this is in several areas of the bond markets including municipal and high yield bonds. Great opportunities also remain overseas as valuations are still far from stretched in many developing and emerging countries. Combine that with a European Central Bank that remains committed to stimulating European growth, and the prospects are favorable. While the energy sector has been devastated due to low oil prices, we will also see beneficiaries from that as well.

Many investors that came of age during the great bull market of the ‘80s and ‘90s maintain a belief that markets should consistently return double digits. They have largely been disappointed with the mid single digit return of 6.5% over the last ten years. Other investors have only experienced the low returns and wild volatility of the markets since 2000 and have become disillusioned. Both types of investors need to reset their expectations.

At the November Schwab conference we heard portfolio managers, economists and retirement planning experts explain that at best, investors should expect 6% average annual returns in the foreseeable future. This is in line with the returns averaged over the past decade. Historically, though, long-term bonds have yielded about 5% and long-term equity markets have averaged around 10%. However, it might be some time before we see these averages again. Dr. David Kelly, Chief Global Strategist and Head of Global Markets for J.P. Morgan recently summarized 2015 as the year of distractions, divergence and distortions. It will take patience on the part of investors as the Federal Reserve raises interest rates to reset to normal. However, we believe that the markets still provide the best opportunity for long-term appreciation, even if returns may be muted in the short term.

Since we can’t predict the future, diversification remains our most powerful tool. As investors we should continue to look at what we can realistically expect in returns from our balanced portfolios. It is never easy to wait to get paid, but when we look back, it always has been the well-diversified portfolio that has made money for investors over the long term. Staying the course is hard, but we hope that our help will make it easier for you. As we start 2016, the global markets have reminded all investors that risks remain. However, we have learned from the past that downturns should be expected and they set the stage for future opportunities. We welcome any questions or concerns that you have. We look forward to guiding you through these times that are difficult for all investors.

Thomas L. Menzel, CFP®                                             Shawn J. Jacobson, CFP®, ChFC, MBA
Asset Manager                                                            Asset Manager
JP Morgan 1Q 2016 Guide to the Markets; www.MarketWatch.com “8 Lessons from 80 years of Market History” Dec 29, 2014; Wall Street Journal, “What to Expect in 2016” January 2-3, 2016; Morningstar.com, Fund Category Returns

IMPORTANT DISCLOSURES: The opinions presented in this communication are subject to change without notice and no representation is made concerning actual future performance of the markets or economy. Information obtained from sources is considered reliable but is not verified. The research and other information provided herein speak only as of it date. We have not undertaken, and will not undertake any duty to update the research or information or otherwise advise you of changes in the research or information. Performance information presented is not an indication of future results and index data is provided for market reference purposes only. This is not an offer to buy or sell or the solicitation of an offer to buy or sell any security/instrument or to participate in any particular trading strategy. This document is the property of Legacy Financial Advisors and is intended solely for the use of the Legacy client, individual, or entity to which is addressed. This document may not be reproduced in any manner or re-distributed by any means to any person without the express consent of Legacy. This material is for educational purposes only. Mis-transmission is not intended to waive confidentiality or privilege.