2016: You Don’t Want to Buy and Hold This Market!

This year has been called “the year nothing worked.” Stocks, bonds, commodities… emerging markets… real estate investment trusts… pipelines… cash… nothing generated much in the way of returns in 2015.

Many active traders, of course, had a good year, and investors that stuck with a handful of high-octane momentum stocks actually did really well. But in looking at asset classes in general, 2015 was a blasé year for investors.

Well, I have good news and bad news.

The good news is that there are pockets of value out there.

As I’ve written recently in Boom & Bust, many closed-end bond funds are priced to deliver very respectable returns over the next 12 months. And similarly, we’re starting to see some opportunities in the sectors that got hammered the hardest in 2015, such as mortgage REITs and business development companies.

But the bad news is that the broad market is still extremely expensive, and priced to deliver very disappointing returns going forward.

The picture doesn’t look quite that bad when looking at traditional metrics like the price/earnings (P/E) ratio. Since stock prices have basically stayed the same as corporate earnings have dragged, the trailing price/earnings ratio has actually jumped.

Of course, some of this is due to the collapse in oil company profits. Either way, it’s a mistake to fixate too heavily on a single year’s P/E ratio. The earnings half of the equation can fluctuate wildly from year to year.

So instead, let’s use one of my favorite valuation tools, the Cyclically-Adjusted Price/Earnings ratio (CAPE), also called the Shiller P/E Ratio. The CAPE compares today’s prices to a 10-year average of earnings as a way of smoothing out the year-to-year fluctuations.

Shiller PE Ratio 2015 Year End

By this measure, the S&P 500 is wildly expensive today. In fact, it’s only been significantly more expensive one time in history, and that was during the 1990s tech bubble.

Today, the CAPE sits at a nosebleed level of 26.2. Research site GuruFocus ran the numbers and found that today’s valuation puts the S&P 500 at 57% more expensive than the long-term average. If history is any guide, this implies annual returns of just -0.2% over the next eight years.

Now, I don’t for a minute expect stocks to trade sideways for eight years. That’s never happened in history, and I don’t expect it to start today. The market will do what it always does: it will be choppy and volatile, giving us plenty of opportunities to buy dips and sell rallies.

But we’re not likely to see any sustained uptrend, and I expect that, once the numbers are tallied, the returns over the next eight years probably really will look close to the GuruFocus estimates.

The takeaway?

Don’t plan on a buy-and-hold strategy in 2016. Search out the pockets of value as you see them, or even use a momentum strategy if that’s more your style. But be sure to stay active, because a passive buy-and-hold strategy is likely to disappoint.

Charles Sizemore

Editor, Dent 401k Advisor

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Categories: Investing

About Author

Charles Sizemore is a research analyst with Dent Research. His primary research focuses on income, retirement strategies and fundamentals.