2015 4th Quarter Commentary
A Fragile Stock Market Hits An All Time High
In 2014 the media was filled with news about the Dow Jones Industrial Average setting record after record high. It closed on December 26th over 18,000 for the first time ever. However, on Jan 6, 2015 the Dow closed at 17,371 – a 667 point drop (-3.7 %) in 5 trading days. Earlier in the year on September 15th the Dow closed at 17,279. By Oct 13th the Dow had dropped 899 points to 16,380. That’s a -5.2 % drop in one month! The bottom line is that even though the Dow Jones Industrial Average set records in 2014, at the end of the year the total return was +7.5%. At the same time the European, Australian and Far East Index* (EAFE), a commonly followed international benchmark, was down -7.35%.
If an investment had been 100% invested in Large Cap U.S. Stocks, it may have approximated the Dow Jones Industrial Average Return. However, that sort of concentration (i.e. having all the eggs in one basket) would have substantially increased the risk. The 3 factors which caused the most market instability in 2014 were:
- Regulatory uncertainties
- Potential interest rate hikes by the Federal Reserve
- Plummeting world oil prices
Toward the end of the year the drop in oil prices revealed how fragile the markets really were. In June of 2014 the price of West Texas Intermediate crude was $105 per barrel. By December the price had dropped to $59 a barrel, almost a 44% drop. On January 8th 2015 it hit $48 a barrel. That is a 54% drop in the price of oil in only 6 months! This dramatic drop in oil prices not only caused problems in the US Stock market, but also in International Markets and sectors of the bond market.
Most people believe a reduction in the price of oil, which leads to lower gas prices at the pump, should be a positive for the US Economy, and that is true to a degree. However, the truth of the matter is that many of our industries derive the majortiy of their profits from exports to foreign countries. Many of those countries (Brazil, Venezuela, Russia etc.) are dependent on the price of oil for much of their revenue.
Obviously, the plummeting price of oil has seriously affected companies in the energy sector. Suddenly oil that was profitable to extract at $105 a barrel did not provide a profit at $48 a barrel. Not only has this put tremendous pressure on the price of their stock, it has also raised questions as to their ability to pay interest on their loans, which has affected portions of the bond market.
Over the years, we have found it prudent and have made it our policy to use a diversity of asset classes. The objective of diversifying asset classes is to attempt to generate a reasonable return in good markets while providing a measure of protection in down markets.
The two times it is most important to stick to our disciplined asset allocations are:
- When the markets are extremely high
- When the markets are extremely low
It is almost irresistibly tempting to buy stock when everyone is celebrating all-time highs and assuming stocks will only go higher. It is also very tempting to sell when markets are extremely low and no one thinks they will ever recover. Having the discipline to stick to our risk tolerance allocation protects us from doing the wrong thing at exactly the wrong time.
*Indices mentioned are unmanaged and cannot be invested into directly. Past performance is no guarantee of future results. Diversification and asset allocation strategies do not assure profit or protect against loss. Sources: Wall Street Journal, Yahoo Finance, Stockcharts.com, MSCI Indexes (msci.com)