The Fed dominated financial news in 2015. It realised during the year that communication is as important as credibility. Yellen and her team deserve proper credit for preparing the markets well. By the time rates were raised in December almost everyone was expecting it. The market quickly settled, showing little volatility. 2016 may yet prove a steeper learning curve for both the Fed and market participants.
Should there be so much discretion given to the Fed? A financial entity with few checks and balances can cause greater harm. Perhaps more so than its usefulness in fulfilling mandates and dealing with financial crises.
Fear is at once the most talked about and yet not talked about word in investing. In behavioural investing, fear paralyses investors or causes them to panic and overreact. Fear is also a technical issue as it influences the discount factor (please see my related post on discount factors and hurdle rates).
Good fear shines the spotlight on problems that are either preventable or manageable. Bad fear is inefficient, making us waste time worrying over issues that are irrelevant. Learning to tell the difference between good fear and bad fear is key to prudent investing.
Prudence means a greater focus on risks. Low growth and sideways markets propel companies and investors to act in riskier ways. For many investors the reach for yield ended badly as high yield bonds sold off. Many companies ran out of room to boost earnings further via financial engineering as economic reality set in.
Profits were down for the first time since 2009 in the US, according to Bloomberg. For many years, all companies rode a wave of rising profits and investors’ returns were helped further by expanding multiples. This came to an end in 2015.
Now we are likely in an age where each company’s integrity and viability increase in significance. When the world fills with even more lemons, we must learn to kick the tyres ever more vigorously. Going forward, risk in all its forms, liquidity, systemic and idiosyncratic could well dominate investors’ thinking, ahead of potential returns.
China’s slowdown and the related commodities meltdown highlighted the real macro issues. “Geopolitical” risks which included Syria and Russia had no impact on the global economy. In Greece and Iran, politicians did enough to avert calamity.
Diversification acknowledges unpredictability and our own fallibility. It does not mean that we should place equal weighting on everything or even that we need to own all asset classes. Diversify wisely.
Finally, currencies drove a lot of volatility in 2015. The decision to hedge or not made all the difference in international investment returns. Any allocation needs to be 100% aware of the implicit currency bets.
Happy New Year, wishing you great risk-adjusted returns in 2016. 🙂
From the FT,
US and European equities slid on the final trading day of 2015 in thin and choppy trade, with the benchmark US equity index closing out the year with a loss after three years of double-digit gains.
The S&P 500 declined 0.9 per cent to 2,044 on Thursday, as selling pressures materialised in the final hour of the New York trading day. The index finished 2015 with a loss of 0.7 per cent, its worst annual performance since the financial crisis in 2008 when it declined 38.5 per cent.