Market Overview 4th Quarter 2015

1. Market Overview, 4th Quarter 2015 Thomas J. Barrett, CPA, CFA, CFP
January 11, 2016
United States
The U.S. GDP for Q3 was revised up to a 2.1% from 1.5% previously
reported. Q4 GDP looks weak, but the December jobs surprised on
the upside. Three years of production growth ended in November as
the PMI came in under 50, indicating U.S. manufacturing contraction.
Companies are struggling with emerging market slowdowns, a strong
dollar and the collapse in energy and natural resource activities.
According to Dealogic, global M&A reached $4.3T, exceeding 2007's
record. Dow Chemical and DuPont are in talks to combine. Factors
driving M&A action include: a) slower growth, enticing companies to
increase revenues through acquisitions; b) acquirers with excess cash
on their balance sheets; c) low borrowing rates; and d) the growing
influence of activist investors pushing for less cash and more profits.
The Federal Reserve has raised its benchmark short-term interest
target for the first time in nearly a decade. The rate was increased by
0.25 percentage points. The central bank has assured markets that
further increases will come slowly. Because the dollar is the world’s
reserve currency, the Fed tightening could further depress asset
pricing, including emerging-market equities and commodities.
Prices on high-yield securities hit a 6 year low and confidence is down
as the market faced dropping oil prices, concerns about liquidity, the
Fed target rate increase and Third Avenue Management’s meltdown.
Corporate-debt defaults are on track for the highest level since 2009,
with companies having defaulted on $95 billion, according to S&P.
Muni bonds returned about 2%, beating corporate bonds. Puerto
Rico’s Governor announced that the island will likely default on its
debt in 2016, after Chapter 9 bankruptcy laws were left unchanged.
Tighter lending conditions and a higher dollar should create head
winds for the economy and corporate profits. Bloomberg reported
profits were already down 3.1% in Q4 due to plunging earnings from
oil & gas and commodities. The figures reveal the biggest quarterly
drop in earnings since Q3 of 2009. Wal-Mart warned that its 2016
earnings would drop significantly, with its pledge to raise workers'
wages and invest in online sales.
The age of austerity is over. The Senate passed legislation that will
suspend the debt ceiling through March 2017, set the budget levels
for the next two years, and relax the caps on sequestration. The bills
included: increased defense spending; reauthorization of the U.S.
Export-Import Bank; lifting of the ban on crude oil exports; delays in
Obamacare taxes; and extensions of renewable energy tax credits.
Stocks fell about (1.6)% in December. The Dow was breakeven for the
year, while the S&P 500 Index was up +1.4% with dividends. Excluding
Amazon, Google, Microsoft and Facebook the S&P would have been
down (4.0)%. The average S&P stock was down 4% for the year with
30% of the stocks in bear territory (-20%). The U.S. market's Shiller
P/E is currently around 26, 60% higher than the historical mean.
Immediate reasons for concern include a shortage of catalysts for
investors to put more money to work and the limited potential
benefits from any further monetary stimulus by the Federal Reserve.
HighlightsHighlights
US Stocks: S&P 500 rose +7.0% in Q4, but only +1.4% for 2015.
US Monetary: The Fed raised S-T benchmark rate by 0.25% in Dec.
US Fiscal: Congress passed budgets & suspended debt ceiling.
China: The yuan/RMB was recognized as reserve currency.
Brazil: Impeachment crisis grew; the recession worsened.
Commodities: Oil ended the year at $37/bbl., down 31% for 2015.

2. Market Overview, 4th Quarter 2015 Thomas J. Barrett, CPA, CFA, CFP
January 11, 2016
Europe
The European Central Bank said that the bank's quantitative easing
and asset purchases have met or exceeded expectations but that it is
going to take longer than expected to bring inflation up to the target
of 2%. With unemployment still over 10% and lending disappointing,
economists expect the ECB to extend or add to its quantitative easing
program. "Global growth will be lackluster over the next two years as
the slowdown in China and other emerging markets continues to
weigh on the world economy," Moody's said. Near-term, factors like
ECB easing, the weak Euro, and energy savings can boost growth, but
longer-term growth will likely disappoint without structural reforms.
"Slower growth in China since the beginning of 2015 has reduced
euro area exports, in particular, exports of machinery and transport
equipment," according to the European Central Bank. "This has had
adverse repercussions for exporters of manufactured goods, which
account for almost 90% of goods exported to China."
Japan
Japan's 3Q GDP was revised up to +0.3% from negative, meaning the
country did not reentered a recession. The Bank of Japan feels the
status of the economy is better than in previous deflationary periods
because: 1) Japanese profits are at record highs and 2) the tightening
labor market is supporting wage growth.
China
Models of China’s growth, using public and private sector, suggest
China’s real GDP growth rate is 6.0%. Monetary and fiscal stimulus
has supported growth, as China tries to engineer a soft landing.
Currency reserves have declined by over $400B in the past year as
the government has tried to prop up the yuan.
China faces an era of creative destruction, this transformation will
mean converting the existing model of state capital spending on
industrial capacity, infrastructure projects and other construction
that spawns unproductive/redundant factories, ghost cities, and
unneeded roads, bridges, and airports. China could run its biggest
budget deficit in perhaps half a century next year as leaders turn to
government spending to arrest the slowdown in the economy.
The IMF added the yuan to its Special Drawing Rights basket at the
end of November. Effective Oct. 1, 2016, the renminbi will officially
be recognized as a reserve currency. (China’s currency is officially
called the ‘renminbi.’ The yuan is the unit of account.) The yuan will
be used for international payments and in foreign exchange markets,
boosting China's influence in the global economy.
China expanded the limit of one child per couple to two children as
the nation faces a deepening worker shortage. The policy had been
in place since 1979, although it had been relaxed recently.

3. Market Overview, 4th Quarter 2015 Thomas J. Barrett, CPA, CFA, CFP
January 11, 2016
Emerging Markets
Economic slowdown is not limited to China, Russia and Brazil are also
suffering contractions. There is fear emerging markets are signaling a
broader global slowdown. As the Fed tightens, countries without
dollar pegs could see their currencies fall sharply, putting a strain on
companies that have borrowed in U.S. dollars. Credit downgrades are
increasing in emerging markets because of reduced commodity
prices and lower economic activity. S&P downgraded 224 bonds for
emerging-market markets in 2015, up from 206 in 2014.
A political crisis in Brazil has come to a head as its Congress begins
impeachment proceedings against President Rousseff, accusing her
of violating budgetary rules. At the same time, Brazil's recession
deepened in the 3rd quarter into what economists say is the worst
crisis since the Great Depression, as political corruption has halted
investment and caused consumers to reduce spending.
Commodities
OPEC’s determination to hold oil output at high levels will help keep
the oil glut in play into late 2016, according to the Intl. Energy Agency.
Output could increase even more after Iranian sanctions are lifted.
Oil ended the year at $37.04/bbl., off 31% for the year.
Oil prices have fallen so low for so long that investors worry that
some companies won't be able to generate sufficient income to pay
off loans no matter how much oil they pump. On the positive side,
U.S. energy companies are lining up deals to take advantage of the
end of a 40-year-old ban on the export of domestically produced oil.