2015, The Year of Volatility: TGC 2015 Year-End Market Review
Volatility was the theme for 2015, as global financial markets were roiled by exogenous events coupled with fear of the unknown, in particular the extent and size of future Fed rate hikes.
Global economic growth has been anemic as almost all central banks have either remained on hold or eased further. One exception to the rule was the US, where 2016 expected GDP growth of close to 2.5% allayed Fed concerns enough to warrant a rate hike of 25 bp’s in December. Should the US experience acceptable GDP growth in 2016, along with continued low unemployment, we expect the Fed to gradually raise rates throughout the year. This strategy, if effected too quickly, however, poses its own set of risks, since a higher dollar vs other global basket currencies would result in a negative impact to US manufacturing. In other words, our goods become too expensive on the world markets.
Emphasizing risk to the US economy are the Institute for Supply Management (ISM) reports showing a decline in manufacturing activity. A reading below 50 typically reflects contraction, and the last two months ending in December have both resulted in sub 50 readings. As a result, going into 2016, we are cautious about the economic outlook and believe risks point to the downside.
Sadly, the labor market numbers have not reflected reality for many Americans, as discouraged workers who have given up looking for a full-time position are not counted in the general unemployment releases. The true underemployment rate, called U-6 by the U.S. BLS, which includes those employed part-time and people who want a job but have given up looking, has been trending above 10 percent for most of 2015.*
At Tidegate Capital, we see challenges in the year ahead with opportunity in sectors and asset classes where fear will not be the primary driver of returns. Whether the fear is of declining global equity markets, currency volatility, or exogenous shocks including rogue regimes or terrorism, it is evident that investors must include some safe-haven assets as part of their portfolio mix.
Tidegate Capital focuses on real estate, the fourth asset class, and, in particular, multifamily apartments. Multifamily is an often overlooked investment choice for a number of reasons: 1) it incorporates a long lead time and exhaustive due diligence process 2) it requires boots-on-the-ground oversight, which makes it challenging for the average investor to manage on his/her own 3) it may be less liquid than many of the other investment vehicles available, and 4) it may not sound as sexy as owning individual stocks for the investor who likes to tout his portfolio daily.
It is for these same reasons, however, that real estate can provide returns that may often exceed the other sectors while at the same time remaining a stable vehicle of choice for those who can accept a less liquid, longer-time horizon for part of their investments. In the multifamily space, we expect 2016 to reflect positive rent improvements, though not as great as we have seen in the last few years. There remains the potential for increasing valuations primarily in the Class B and C space, since most new construction has been in the Class A space. As a result of the development in the Class A space, pricing increases there will be more muted; however, the demographic shift towards more renters and fewer homebuyers will still be a net positive in all rental classes.
Sector and Asset Class Commentary:
The Bond Markets reacted to Fed speak right from the start of the year, and here is where the fear of the unknown manifested itself the greatest. One chart we follow is the spread for junk bonds, which acts as a proxy for perceived risk in the economy for lower-tier companies, and we clearly saw an uptick in spreads during 2015, implying increased risk for the lower-rated fixed income issuers.
2015 was a challenging year for Alternative Investments as well, particularly for hedgies, as the industry experienced what looks to be the closure of a record number of Hedge Funds since the last financial crisis in 2008. With nearly 1000 Hedge Funds shutting their doors in 2015, the survivors in that industry will be dominated by larger, well-established names. However, the larger the ship, the harder it is to change direction, and we expect many of the top-performing funds to show more muted returns as their bloated size limits flexibility. However, the desire to find returns with low correlation and low risk to traditional asset classes remains, and the Hedge Fund industry will create ever-more complex strategies to meet their investors' needs.
Commodities: The slowdown in China, a strong U.S. dollar, and low oil prices (along with many other commodities including base metals) will make this asset class a challenge for all but the extremely nimble and brave. Due to the current supply glut, low oil should support airline stocks, shipping, and rail as they experience increased margins. The wildcard will be rising Middle East tensions, and, while always a concern, they could set off a short-term supply shock should conditions there deteriorate further.
In the U.S., Equity Markets ended the year mixed, though ending where one started the year and enduring all the rough patches and bumps along the way certainly makes for a lot of sleepless nights for investors. When we began 2015, every financial prognosticator who worked for the large investment banks or fund complexes predicted a solid year for the U.S. stock market, and nearly every one expected the Fed to raise the Funds rate early in the year. Clearly, neither was the case, and while we don’t view ourselves as necessarily better (and certainly not worse) market prognosticators than some of the street economists, it is their inability to think outside the box that limits creativity and oftentimes the ability to see the proverbial forest for the trees. We trust that you, our readers, will start to think outside the box and consider the fourth asset class as an option.
Please feel free to re-read our Prior Market Commentary for full transparency, and review the article from Marketwatch in December 2014, for details on the street economists 2015 forecasts: http://www.marketwatch.com/story/rate-hikes-volatility-not-expected-to-kill-bull-market-in-2015-2014-12-17
In closing, we at Tidegate Capital hope all our readers have a healthy and prosperous 2016. We look forward to providing you with regular quarterly updates and market commentary. We welcome your feedback.