Stock Market Smarts: Put Safety First in 2016

The worst start in Wall Street’s history does not portend well for the year ahead.

Well, that was rather ominous.

The worst start to a New Year in the history of Wall Street does not portend well for the coming months. If what happened so far this month is any indication, 2016 looks like another rough year for investors. I wish I could say those big sell-offs spooked by events in China were just an aberration but I can’t. There are very few bright spots on the horizon.

The root of the problem, I believe, goes back to the years immediately following the Great Recession of 2008-2009. Stock markets rallied in anticipation of a global economic recovery that has never truly materialized. Prices got ahead of themselves to the point where even after last year’s mediocre results the S&P 500 still looks expensive.

The situation has been exacerbated by the bitter battle over oil market share that has resulted in the lowest prices since 2008. Compounding the malaise is the economic slowdown in China, the on-going weakness in commodity prices, and the strong U.S. dollar, which is now beginning to have a deleterious effect on the American recovery.

This is the backdrop against which the economic forces of 2016 will play out. It’s not encouraging so my advice is to put safety first.

Raise cash, hold bonds, and stay defensive in your stock investments. At this stage, preservation should trump profit.

Click through for my 8 predictions on how this year will shape up.

More grief for the TSX.

It would be nice to see the TSX rally from last year’s dismal performance. But we need a catalyst and it’s hard to see where that will come from.

The energy sector (18.5 per cent of the index weighting) remains in the grip of the global price war. Tstock-exchangehe materials sector (9.75 per cent) continues to be dragged down by depressed demand and pricing.

The financials sector (38.11 per cent) is a little healthier but the bank stocks have been under pressure overinvestor concerns that the weak Canadian economy will dampen profits.

Without a major rally in at least one of those sectors, it’s hard to see the TSX doing much better than break-even in 2016 and a second straight losing year is a real possibility. That hasn’t happened since 2001-2002, but don’t rule it out.

A slightly better year on Wall Street.

The U.S. economy is in better shape than Canada’s although the strong greenback is hurting the profitability of companies with a large interWall Streetnational presence.

History suggests that the S&P 500 should do better this year than in 2015, when it slipped by 0.73 per cent. An article in the Wall Street Journal last week noted that after years when the index was virtually flat, it posted a double-digit return in the following 12 months in all but one instance.

Also, this is a presidential election year in the U.S. According to Sam Stovall, U.S. equity strategist at S&P Capital IQ, the S&P 500 has risen an average of 6.1 per cent in the fourth year of a presidential cycle since 1948.

But Wall Street has already dug itself a deep hole. After the close on Jan. 7, the S&P 500 was off 4.9 per cent for January while the Dow was down 5.2 per cent. Barring some dramatic change, I think the best we can hope for is a modest single-digit advance in New York.

No joy for oil.

drilling tower

Low oil prices have resulted in increased demand but oversupply still remains a huge price depressant. Until a balance is achieved, which may be two or three years away, energy companies will continue to struggle. This is a situation in which a black swan, such as a shooting war between Saudi Arabia and Iran, could dramatically change the scenario.

But barring that, it looks like more of the same for the oil patch in 2016. That doesn’t mean investors should avoid the sector entirely, but the focus should be on major companies with strong reserves and downstream assets. Suncor, ExxonMobil, and ConocoPhillips are examples.

Europe keeps surprising.

Euro

European stocks did better than expected in 2015, with the Stoxx Europe 600 up 6.8 per cent, and we could see a repeat this year, despite the weak start.

The European Central Bank is being highly accommodative, with a quantitative easing program similar to the tactic used by the Federal Reserve Board to nurse the U.S. economy back to health.

The interest rate on money deposited with the ECB is at a record low of -0.3 per cent. The German economy continues to be strong with the OECD forecasting GDP growth of 2.3 per cent this year.

Emerging markets will struggle.

The year just ended was a bad one for emerging markets.

The MSCI Emerginemerging marketsg Markets Index is down 18.4 per cent in the past year and there is no reason to expect 2016 to be any better given the problems in China, Russia, Brazil, and elsewhere.

Many of these countries are carrying U.S. dollar debt and the high greenback is adding millions to interest costs. Low oil prices are hurting producing countries from Venezuela to Nigeria to the Persian Gulf. Steer clear for now.

Bonds still worth holding.

Upward graph

The U.S. has started to gradually raise interest rates but most of the rest of the world, including Canada, is maintaining a low rate policy in the face of weak economic growth.

Contrary to what most people expected, Canadian bonds delivered modest profits in 2015 and outperformed the stock market by almost fifteen percentage points.

I expect bonds to beat Canadian stocks again this year, although the margin will be narrower.

downward map

Bad times for the loonie.

Absent a recovery in the oil price, it’s difficult to make a case for a stronger loonie.

The Bank of Canada is unlikely to raise interest rates in 2016 while the U.S. Federal Reserve Board could hike its benchmark rate at least once and possibly as many as three times. That will continue to put downward pressure on our currency. I hate to say it but US$0.65 is not out of the question.

Cash is king.

During times of market turmoil, there is nothing wrong with holding cash.US Dollar

Right now, that would be U.S. cash, given the grim prospects for the loonie. Cash doesn’t provide much return but it cushions the portfolio against loss, provides liquidity when buying opportunities appear, and allows you to sleep better at night.

The bottom line is that capital preservation should be your main priority this year. There are times to be daring in the market and times to hunker down. This is a hunkering year.

 

Gordon Pape is Editor and Publisher of the Internet Wealth Builder and Income Investor newsletters. For more information and details on how to subscribe, go to www.buildingwealth.ca.

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