2016 Market Outlook: Welcome Back Volatility

2016 has started off with increased volatility and sharp declines in all equity markets, here and abroad. At First Long Island Investors we seek to understand the markets to make sound, unemotional, decisions regarding long-term investing.

Drivers of Volatility:

There are a few main factors giving investors concerns and creating the current volatility. First is the steady decline in the price of oil. Oil plummeted nearly 30% in 2015 (almost 65% from its recent high!) raising worries about global growth. Uncertainty relating to when the Federal Reserve would raise interest rates was a cloud over 2015. After seven years of “0%” interest rates, the Fed finally raised rates in December of 2015 and now investors are concerned with the pace and frequency of subsequent rate hikes. China’s economy, the second largest in the world, continues to decelerate. We expect that its economy will continue to slow, yet still grow between 4% and 5% per annum, which is constructive. Finally, geopolitical unrest including the potential for further terrorist attacks associated with Middle East turmoil has many worried.

Positive Signs:

There are positives that investors should be mindful of. The U.S. economy is growing modestly, but sustainably, with stronger employment and modest GDP growth. Unemployment dropped to 5% in 2015 and wage growth started to gain some traction. Consumer sentiment is strong and corporations are doing reasonably well. S&P 500 corporate earnings for 2015 are expected to be ever so slightly down, after years of growth, with this pause being largely attributable to the strengthening dollar, which has reduced the earnings of many U.S. domiciled multinational companies, and the plummeting price of oil. We believe that many companies will continue to grow earnings and, in general, are trading at a reasonable P/E of approximately 16 on 2016 projected consensus earnings, which to us is fairly valued. We remain convinced that the U.S. is not headed for recession for the next several years.

What We Expect for 2016:

Interest rates will increase slowly this year. Bonds will provide little if any return and in some cases a negative return (high-yield could be the exception). Cash will continue to provide virtually no return. S&P 500 earnings will grow modestly, especially with the appreciating dollar being less of a factor (historical analysis shows the dollar declines in value after interest rates start to rise). Housing will remain robust and contribute to an expanding domestic economy. Oil will bottom out in our opinion at something close to current levels. Inflation will remain reasonable at no more than 2%. Congress will attempt to tackle tax reform with a view towards making our corporate tax rates more competitive globally. The fight against Islamic terror will intensify through a U.S. and moderate Arab-led coalition. A new President will be elected. The Chinese economy will continue to slow as it transitions from an infrastructure/industrial based economy to one that is more consumer/consumption driven. Other emerging markets that are commodity-driven face recession. And yes, there will be more volatility in the stock market!

Our Approach to 2016:

First Long Island Investors believes in crafting prudent and diversified asset allocation strategies for our clients to preserve and grow their capital over the long term. A diversified asset allocation was key to most of our clients achieving reasonable relative 2015 performance in a difficult investment environment by having an exposure to large-cap growth companies, which outperformed large-cap value companies by almost 1000 basis points! In this environment, we believe that underweighting fixed income, being tilted to defensive strategies (ones with low beta or those that are less correlated to the equity markets), maintaining an allocation to traditional equities, and keeping a quality bias in investments is how investors can best weather this storm. We remain focused on the fundamentals of the companies we invest in.  We believe the key is finding and investing in reasonably valued companies with above-average revenue and earnings growth, companies with strong dividend growth, deep value companies where catalysts exist to trigger appreciation, and real estate oriented opportunities with high current yields. We advise investors to remain aware and mindful of the things around us, but not to let emotions and fear take over in making investment decisions. Investors must be prepared for continued volatility. Despite this, we remain convinced that through careful and objective research there are ample investment opportunities for quality and defensive-minded long-term investors.

*This forecast is based on the reasonable beliefs of First Long Island Investors, LLC as of 2/23/16, are subject to change at any time based on market or other conditions. Past performance does not guarantee future results. Actual results may differ materially. This is not an offer or solicitation for the purchase or sale of any security and should not be construed as such.

Robert D. Rosenthal

Robert D. Rosenthal is Chairman, Chief Executive Officer, and Chief Investment Officer of First Long Island Investors, LLC, a wealth management firm focused on providing high net worth clients with individualized advice and counsel for the preservation, growth, and administration of their wealth. Since starting the company in 1983, Mr. Rosenthal and his team have earned the trust of their clients by investing their own assets alongside those of clients, delivering exceptional service, and using their expertise to provide sound advice through a breadth of life experiences and investment environments. For more information, visit www.fliinvestors.com