A Glimpse Into 2016

Greetings! I hope that this finds you well and enjoying life.

The New Year got off to a rocky start as investors digested falling equity markets, further declines in the price of oil, heightened concerns over China’s economic stability and rising geopolitical tensions. The widely expected “January effect” on risk assets seems to be skipping markets this year. In our view, this recent market activity reflects several long-term market transitions that we expect to play out across the globe in 2016 and beyond.

China is an economy in transition from an external/export focus to an internal consumption/service focused model. In addition, the world’s second largest economy is currently navigating the maturation of its financial infrastructure. This transition from central planned to market-driven will take place over several years and will clearly not be a smooth ride. Recent missteps, including tight equity-market circuit breakers and a less-than-transparent plan to adjust the long-term yuan peg, have all contributed to the heightened uncertainty regarding future economic growth and the ability of China’s leaders to pull off this evolution without a major short-term adjustment.

Global energy sectors are also transitioning to the new supply/demand reality of the oil markets. New countries coming online, advancing extraction technologies and the commitment of current producers to maintain market share, have all boosted the supply of oil well in excess of current demand. The ensuing dramatic drop in the price of oil has caused substantial weakness in shares of energy-related stocks, currencies of energy exporters and credit spreads on energy debt. This transition to a more-balanced supply/demand picture will also take some time, as the market heads toward maximum storage capacity and as high-cost producers shutter projects.

Last but not least, monetary policy in the U.S. is also transitioning from zero rates and extraordinary measures to higher interest rates and tighter (but not tight) policy. Along the way, the U.S. Federal Reserve (Fed) must not only find the right terminal policy rate that reflects the challenges of a potential “New Normal” economy — which is characterized by slower growth and lower inflation than history would suggest — but that must also identify the right path to get there. This transition will not only be slow to play out, but will also be highly dependent on the data, including on steady economic growth and inflation finally approaching the Fed’s 2% target.

So what should investors do in this market environment? Sell and go to cash? Take advantage of lower prices? We think the first thing investors should do is to reaffirm their goals, their time horizons and, most importantly, their risk tolerance. It is natural for investors to have short memories during an extended bull market, and even allow the risk in their portfolios to rise during times of muted volatility and high returns.

Consider the fact that the S&P 500 Index exhibited roughly 15% volatility, as measured by the standard deviation of daily returns during calendar year 2015. This is about equal to the long-term historical average volatility of the broad equity market. Even the negative start to 2016 is hardly unique for this or any bull market. In fact, since March 2009, the S&P 500 Index has experienced five independent periods with losses greater than 8%, three of which were greater than 10%. Investors uneasy with this level of volatility should revisit, and perhaps rebalance, their strategic asset allocation to ensure that their risk tolerance is accurately reflected. In addition, we believe active management can have a meaningful effect on asset-class returns during periods of volatility, and would recommend a more active approach where appropriate.

The market has reacted strongly to the uncertainty surrounding many of these issues; however, we feel that this recent correction is not a harbinger of an extended bear market. The level of economic activity and improving employment picture, particularly in many parts of the developed world, are simply not suggestive of recession. Valuations are slightly above long-term averages, but are far from stretched. And central banks, including the Fed, are maintaining highly accommodative monetary policies. The market may struggle to discount the uncertainty of China’s real rate of economic growth or where the bottom in oil prices may be; however, we still firmly believe that a well-diversified portfolio that is accurately reflective of your risk tolerance is still the right strategy for 2016.

If I can provide information on any of the above or assist you in your retirement planning don’t hesitate to call.

Best regards,

Jeff Christian CFP, CRPC

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