Last year wasn’t a great one for investors seeking solid returns.
No year since 1990 has seen more asset classes finish in negative territory than 2015, even if losses were more extreme in 2008, according to a BlackRock analysis using Bloomberg data and looking at the average of annual total returns for oil prices, gold prices, ten fixed income indices and three equity indices.
In fact, according to the Bloomberg data, in 2008 there were arguably more places one could take refuge, as U.S. Treasury and Agency debt, broad aggregate fixed income indices and gold all provided a bulwark against steep equity losses. In contrast, last year, while the extent of losses was more muted than in 2008, losses were more widespread across asset classes, the data show. Given the correlation between asset classes, there were fewer opportunities to sidestep trouble and take refuge.
What can we expect from markets this year?
With 2016 off to a rocky start so far, you may be wondering whether we’ll see more of the same this year. While I don’t have a crystal ball, here are three things I believe all investors need to know about returns in 2016.
1. Solid returns will remain hard to come by. Unfortunately, as this year kicks off, many of the challenges that made positive return generation difficult in 2015 are likely to persist. In developed markets, these challenges include long-term interest rates that are still near multi-decade lows, as well as elevated equity valuations.
Indeed, even as the Federal Reserve (Fed) began the process of rate normalization late last year, it left interest rates unchanged at its policy meeting this month. In fact, given that the U.S. labor market likely experienced its cyclical peak at the end of 2015 and the Fed began raising rates too late in my opinion, current Fed Funds futures are pricing in essentially only one hike in 2016, according to data accessible via Bloomberg. In short, rates will remain low for the foreseeable future.
2. Returns will be far from uniform within asset classes. During the last few years, return dispersions within asset classes have been dramatic. According to an analysis using Bloomberg data, the top ten names in the market capitalization-weighted S&P 500 Index have provided an outsized contribution to the index’s total return in recent years.
Similarly, return dispersion by sector has also been remarkable in recent years, in my opinion. While the consumer discretionary, technology, and healthcare sectors have held up relatively well, other sectors (like energy, utilities and material) haven’t. Further, this kind of dramatic return dispersion hasn’t been limited to the equity world; it has also been happening in the fixed income space, the data show. In other words, while many asset classes experienced moderate losses in 2015, those losses tended to be concentrated among certain names and in certain sectors and industries.
Looking forward, I believe this return dispersion will continue, and even accelerate, this year. This is because it’s at least partly a result of important trends transforming the global economy and markets, including shifting demographics and the influence of new technologies. It’s also a reflection of ongoing fears over the impact of China’s growth slowdown on commodities and other emerging market economies.
3. Returns will stay volatile. Remarkably, return contributions in 2015 weren’t just concentrated by name; they were also concentrated by date. Missing a few of the best days of the year would have greatly injured annual returns, while avoiding the worst would have greatly aided them (with news out of China being a key swing factor). This trend too is not going away anytime soon, not least because concerns about China will continue to weigh on markets.
So what does this all mean for your portfolio? I don’t mean to imply that you should give up hope of achieving a decent return in 2016 and run for the sidelines. Rather, taking a closer look at how the return landscape is likely to shape up this year, and for years to come, shows that it’s more important than ever to be selective as you take risk in search of returns. In fact, I believe there will be pockets of attractive returns; we just all need to sharpen our focus on which assets will perform, and more specifically, which geographies or sectors within these asset classes will perform.
Where to look for opportunities
Whether you have a short- or long-term investing horizon, gaining a better understanding of the transformative long-term trends behind today’s return landscape can potentially provide you with an opportunity advantage as you make your investing selections. These trends include the changing global liquidity, leverage and cash flow landscape as well as the technological innovation and demographic changes I’ve long been writing about.
Economies and markets today are in the process of adjusting to what might be the most dramatic technological evolution in history, alongside of dramatic changes in the demographic makeup of many countries. These massive secular changes should neither be seen as theoretical future events, to be worried about at some later date, nor should they be taken as hyperbole, as they are in fact very real and they are already influencing our economic and market landscape. The changing return landscape testifies to that.
So if you can, try to tune out the daily market noise and focus instead on how these big-picture shifts could impact portfolios over the longer term. The important trends that will influence the global economy for decades to come are already upon us, and you must examine for a better understanding of how market dynamics are likely to unfold. Their impact will not be felt equally by country, sector and industry. Rather, return divergence and dispersion will be the order of the day.
Rick Rieder, Managing Director, is BlackRock’s Chief Investment Officer of Global Fixed Income and is a regular contributor to The Blog.
