Regions Wealth Management's CIO highlights his outlook and opportunities for the year ahead
The year 2015 saw an end to the sustained bull market, volatile domestic and international markets and continued slow growth in the U.S. economy. So what's in store for 2016?
Alan McKnight, Chief Investment Officer of Regions Wealth Management in Birmingham, Ala., recently offered his economic and investing outlook for 2016 and provided insights on how investors can prepare their portfolio for the year ahead.
Q: Stock investors had a pretty bumpy ride last year. What are you expecting for the U.S. markets this year?
McKnight: We had anticipated the volatility we saw in 2015, and we expect a similar experience in 2016. We've had a virtually unprecedented run in the stock market over the past six years, and that recovery is getting long in the tooth. We think there will be additional volatility as global growth begins to slow. When events occur like what happened in August 2015 — when China lowered its growth forecasts — they will have a major impact on the markets.
Q: The U.S. economy and labor market grew slowly but steadily in 2015. Where do you see the economy going in 2016?
McKnight: We think the economy will continue on a low-growth course, somewhere in the mid-2% range for the year. The economy will continue to benefit from a decline in commodity prices, particularly oil. Consumers have effectively received a tax rebate over the past year, thanks to lower prices at the pump and lower natural gas and electricity prices. If that continues, it will help boost consumer spending. The energy price decline will hurt job growth in energy-producing states, but the impact on gross domestic product (GDP) is outweighed by lower energy prices that benefit everyone.
We are keeping a watch on the labor side. Historically, an unemployment rate below 5% has put pressure on wages. As of late 2015, unemployment was sitting at 5%. Upward pressure on wages would put downward pressure on corporate profit margins and earnings and may spur inflation more broadly. Right now, companies still have a lot of levers to pull, utilizing temporary and consulting workforces to increase or reduce their staff. And the sentiment gauges suggest that the labor force itself is still a little uncertain about the future; they don't really feel there's been a recovery. So we're not quite at the place yet where workers across all sectors feel like they have the leverage to demand higher wages.
Q: The economy can influence presidential elections. We're still 10 months away, but do you have a sense of where the economy might be on Election Day?
McKnight: We anticipate the economy will still be in a low-growth state in November. As a result, it may have little impact on the election either way. But the election may influence the Federal Reserve's interest rate strategy, even as early as this spring. The Fed never wants to be seen as playing a hand in politics, so it may be hesitant to make any major moves that could become part of the political dialogue.
Q: What do you see the Fed doing with interest rates in 2016?
McKnight: Economic data has been marginally less positive than we had hoped, which is why the Fed delayed rate hikes until December. They didn't want to rock the boat. With the modest 25 basis point increase, the Fed has effectively stated that the economy is on firm footing. More importantly, they will be prudent and gradual with any additional rate hikes in 2016.
Q: What is your prediction for the bond market?
McKnight: We're concerned that prices are too high, and we're not being paid as much for taking on risk. At this point, we favor shorter-term, investment-grade, higher-quality credit until we get a better sense of what will happen with interest rates.
Q: What's the impact of the global economic slowdown on the U.S.?
McKnight: Global economic integration is increasing by the day, so the impact of the global economy on the U.S. will continue to grow. Take China and its lowered growth forecasts, for example. With 7% growth, it's still well ahead of the developed world. But it's a massive economy, and it will face a challenge transitioning to a more consumer-driven model. China's slowdown will create volatility, and the Chinese government will not be able to just push a button and engineer a soft landing. But the long-term hope is that major emerging markets like China, India and Brazil can evolve into more consumption-driven environments, and that will create opportunities for U.S. companies.
Q: The investment performance of emerging markets has been disappointing for a few years. Should emerging markets still play a role in investors' portfolios?
McKnight: We believe in the benefits of the long-term demographic trends in emerging markets. But our investment management team has underweighted emerging markets because we felt like we weren't getting strong enough returns given the amount of volatility we were experiencing.
Q: Given the expected volatility in stocks and bonds in the year ahead, should investors be looking at alternative investments?
McKnight: We've shied away from hard-asset alternatives like real estate investment trusts (REITs) and master limited partnerships (MLPs) because we sensed that people were chasing yield. In late summer 2015, our fears proved to be well-grounded, and there was a considerable sell-off. These assets still aren't inexpensive enough to generate much opportunity.
We are, however, interested in diversified strategies, given the challenges of generating returns in both bonds and stocks. One example of a diversified strategy is managed futures, which involves buying into markets that are trending higher. We're also interested in equity long/short funds, which attempt to capture the upside of stocks but also hedge against the volatility with a short-selling component. In both areas, the goal is to generate returns while being mindful of risk.
When considering any fund that offers these strategies, it's important to closely examine the function they are meant to play in a portfolio and not just compare them to a benchmark. For example, you would not necessarily expect a long/short equity fund to outperform the Standard and Poor's 500 Index in a boom year. Its goal is to generate excess returns over a multiyear period with a meaningfully lower risk ratio.
Q: How should investors position their portfolio in 2016?
McKnight: Investors should expect relatively low returns and more volatility. This environment makes it tempting to chase performance — to sell what appears to be an underperformer and buy a fund that has done well over the last six, 12 or 18 months. But market-beating performance is very hard to replicate. That fund manager has a low likelihood of achieving that high outperformance over the next 24 months.
It's better to take a more holistic approach. The beginning of the year is a good time to sit down with your advisor to take a hard look at your investment goals. What level of assets do you hope to accumulate? What is your desired cash flow? In this environment, is your current investment program likely to allow you to reach those goals? If not, then you may need to make an adjustment. Perhaps you need to save or invest more each month, or withdraw less each month. Or you may want to consider changing your risk level.
All too often, investors “set it and forget it.” But that approach rarely works well, because the investing decisions you made five or 10 years ago may no longer be appropriate for the current investing environment.