Twelve months ago, we suggested stocks would increase 8%. That was off the mark, but less so than other widely held predictions of double digit returns.
We forecast that 2016 will be a better year for the US stock market. We see stocks rising moderately between 5% and 6%. We agree with certain strategists that the key driver of stocks will be moderate earnings growth of 6% to 8% and a somewhat tepid 2 1/2% GDP growth. None of our Wall Street sources expect a recession.
We do not anticipate an expansion of the market’s price/earnings multiple, which is currently at 16.0 times analysts’ consensus 2016 estimates. We believe stocks aren’t cheap, nor are they rich, given a long-term forward P/E average of 15.
While no surprise, Hall Capital is predicting another high volatility year for stocks in 2016. Worries could include oil prices continuing to fall further; that the Federal Reserve will raise interests more than “gradually”; that a geopolitically inspired shock, especially a potential global terrorism threat, could occur; that China, the world’s second largest economy, continues to slow down.
For clients investing in individual stocks, we will maintain our common stock discipline of focusing on stocks of large capitalization companies which tend to be industry leaders – or are gaining market share. In a world of somewhat slow economic growth and modest profit expectations, we feel the most dependable returns will come from companies with strong finances and stable earnings. Such high quality shares usually stand up well to market volatility as suggested earlier.
Our favorite sectors during the coming year are technology, health care, and consumer staples. Their valuations seem reasonable to us. Their balance sheets are generally strong, and their moderate earnings growth seems reasonable to expect. We feel that worries about a strong dollar, sluggish global growth and plunging oil prices have weakened the attractiveness of most other sectors.
While we are more positive on domestic stocks than international stocks, we are upbeat on European stocks to gain in 2016. We are influenced by the easy money policies from the European Central Bank and an expected rise in corporate earnings. For certain clients, we like European equities for further portfolio diversification.
Our bond and stock mutual fund approach for 2016 will not change. Our experience over many years is that a diversified blend of funds representing different styles and sizes, with relatively low expense ratios, having achieved competitive rates of return with below average risk (volatility), will prove effective over time.
As the Federal Reserve gets ready to raise interest rates, our prediction is that the rates will not climb much. As the Fed said at its October meeting, global economic growth is “tepid” and inflation remains “persistently low”. A strong dollar also should keep rates from increasing a lot because it encourages foreign investors to buy our bonds.
We expect the yield on the 10-year Treasury bond to range from 2.15% to 2.75%. We anticipate bond prices and yields will bounce all year within that range. Our yield forecast dictates we primarily adhere to our core bond strategy – which stresses high grade with medium maturity dates. While the bond yields are historically low today, bonds nevertheless are especially useful as a stabilizing influence on the entire portfolio especially when the stock markets are volatile and if a correction develops. We acknowledge that lower quality bonds with long maturities could earn more income, but we believe that the increase in income is not worth the increased risk.