The Dow Jones Industrial Average, a collection of 30 well-known stocks, finished 2015 just shy of 17,500.
For those who don’t pay particularly close attention to such stock market barometers, you haven’t missed much lately. The Dow also traded at the same level in November – and the November before that.
Together with paltry interest rates paid on other investments, you can’t fault an investor for wading through their stack of year-end statements and wondering “where’s the beef?” For the most part, investors received what amounted to a “big fluffy bun” in 2015, to borrow further from the iconic Wendy’s commercial.
While a flat year is tolerable, even patient long-term investors want to know if 2016 offers the promise of more substantial returns. To address this question it is helpful to invoke the spirit of the two-headed Roman god Janus and first look back before we look forward.
The Federal Reserve’s massive experiment of printing money to buy bonds began in earnest in 2009. While the policy continues to be highly controversial there is no debate that the Fed met its objective of suppressing interest rates and simultaneously lifting stock prices.
In late 2014 the Federal Reserve announced that they would curtail the creation of billions of dollars each month for their bond-buying escapade. It was hardly coincidental that the announcement marked the advent of the market’s now 14-month stagnation.
Financial markets spent 2015 wondering when the Fed would take another gradual step towards cooling the economy in the form of raising interest rates. Janet Yellen and company finally raised rates by 0.25% in mid-December. The announcement was well telegraphed. It’s also no surprise why stock prices didn’t advance in anticipation.
Looking ahead, the Fed has telegraphed additional interest rate hikes in 2016. The jury is out (and sharply divided) as to whether such hikes will actually materialize, but the mere potential of higher rates is certainly sufficient to keep stocks stuck in the mud.
While I volunteer no ability to forecast future stock market performance, it is my increasingly fervent opinion that investors have generally underappreciated the influence of the Federal Reserve policies on their returns. For six years the policies fueled risk taking and higher asset prices, creating valuations that are increasingly divorced from intrinsic value. Now the Fed expects to gradually increase interest rates, thus replacing the strong tailwinds of recent years with increasingly stiff headwinds.
Stock prices remain elevated due to the Fed’s policies of prior years. While the market’s stagnation is frustrating for all, the reality is that investors should consider themselves fortunate to chew on a big fluffy bun again in 2016. Another flat year for stocks would offer investors time to digest the impact of higher interest rates. It would also afford companies an opportunity to post higher profits and larger dividends, thus allowing them to grow into their current stock prices, undoubtedly the most comfortable way for the market to return to a more reasonable valuation.