Winners and Losers from 2015, and a Peek at the Year Ahead

As we close the door on 2015, many investors are still trying to make sense of the last 12 months. To recap, it’s been almost a year since the Federal Open Market Committee (FOMC) decided to end quantitative easing (QE). Since that time, most equity and debt markets around the world have traded flat-to-negative, except those regions where QE is still in place.

As was the case in 2015, the countries with the most aggressive monetary policy will likely enjoy the best stock market performance in 2016. The lesson here is that money moves markets. Just look at The Bank of Japan: It maintained the most aggressive monetary policy in 2015 and the Nikkei-225 index is the best-performing major developed market, up 10.2% year-to-date.

Size Matters

In the early stages of QE, small cap stocks tend to outperform large caps, as liquidity tends to drive capital into risk assets. This can be seen in European stock performance, where small caps are currently outperforming large caps. Asset class outperformance should rotate from small caps to large caps.

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In the United States, the nifty-fifty stocks (-0.91% ytd) outperformed small cap stocks (-7.4% ytd) by 649 bps, despite a strong dollar. Small cap stocks outperforming large caps earlier in the year was unusual, considering the economic slowdown.

Risk Matters, Too

The credit markets usually sniff out problems in corporate balance sheets before equity investors do. By mid-year, high-yield bond investors began demanding additional compensation for rising default risk.

The high-yield bond market offered early clues for investors to move into higher quality companies, especially during the fourth quarter when the widening of credit spreads moved into other sectors besides energy and materials.

Unfortunately, cap-weighted index funds don’t provide investors with the luxury of owning higher quality companies; and neither do value stocks.

It’s Micro, not Macro

Investors that didn’t make a distinction between growth and value lost an opportunity to capitalize on a 1,000+ basis point differential in return, year-to-date.

While I don’t recommend that investors take an all-or-none investment approach, I have recommended overweighting asset classes based on their probability to outperform and recognizing the 30-year pattern of asset class outperformance. Both of these processes would have led investors to overweight large cap growth this year—increasing their overall success.

If an investor bought an index fund in 2015, they basically bought a portfolio of stocks that worked against each other. A strong dollar tends to create a pricing disadvantage for multinational companies that can negatively affect earnings. S&P 500 companies derive somewhere around 40% of earnings outside the U.S. How can investors maximize returns when they own a portfolio of stocks in which half the companies doing well are offset by the other half hurt by the strength of the dollar?

Outlook 2016

With all of this taken into account, what can we look forward to in 2016?

First of all, don’t underestimate the power of QE in its ability to trump fundamentals. Investors shouldn’t bet against the central bank’s ability to drive stock prices higher. In the absence of QE, performance is driven by fundamentals.

Additionally, in periods of uncertainty, performance is driven by quality. In the absence of economic growth, large cap growth stocks outperform. If you want quality balance sheets, look to large cap growth.

Lastly, when the market struggles, don’t buy the market. Buy stocks selectively and incorporate strategies that increase the probability of success. Invest in quality balance sheets, large over small, growth over value, active versus passive, utilizing nimble managers with concentrated portfolios.

The opinions referenced are those of Rick Golod and are subject to change at any time due to changes in market or economic conditions and may not necessarily come to pass. These comments are not necessarily representative of the opinions and/or views of other Provasi Capital Partners LP professionals. The comments should not be construed as recommendations, but as illustrations of broader themes. Forward-looking statements are not guarantees of future results. They involve risks, uncertainties and assumptions. There can be no assurance that actual results will not differ materially from expectations. Past performance is neither indicative nor a guarantee of future results.

Provasi Capital Partners LP and/or its affiliates may sponsor, co-sponsor, and/or distribute securities in investment sectors reviewed in this material.

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