Outlook December 31, 2016

DAWN OF A NEW ERA? MARKET OPTIMISM TRUMPS UNCERTAINTY.

Market volatility continued in the fourth quarter of 2016 amidst uncertainty about the U.S. Presidential election as well as overseas economic and geopolitical tensions. For the better part of 2016 the U.S. faced an election that was too close to call allowing mood swings to underpin economic news as time wore on. The S&P500 Index declined 4% between September 30 and the Friday before Election Day. In the early morning after the election, futures markets traded down sharply as the results became clear. Yet, by the time markets opened, in an abrupt about-face, the markets had reestablished pre-election levels and the S&P500 Index rallied over 7% through year-end.

Markets
In the fourth quarter the S&P500 Index earned a 3.8% total return rounding up the strong year-to-date return to 12% for the year ended December 31, 2016. Inspired by the results of the Presidential election in November Small Cap Stocks surged 8.8% in the fourth quarter, chalking up a 21.3% total return for the year, as represented by the Russell 2000 Index. Foreign equity returns were lackluster during the quarter as indicated by the declines MSCI EAFE Index and the MSCI EM Index, 0.7% and 4.1%, respectively. Emerging Market equities had a strong year with an 11.6% total return.

Market Indicies (Total Return as of 12/31/2016)
4thQ% YTD% 3-Year%* 5-Year%*
S&P 500 3.8 11.9 8.9 14.6
NASDAQ Composite 1.7 9.0 10.2 17.2
Russell 2000 8.8 21.3 6.7 14.5
MSCI EAFE** (0.6) 1.6 (1.0) 7.1
MSCI Emerging Markets** (4.3) 11.2 (2.3) 1.6
Source: Bloomberg Finance L.P; *Annualized; **USD

Economy and Interest Rates
In December the Federal Open Market Committee voted to increase the Federal Funds rate by 0.25%, to a range of 0.50% – 0.75% range. In anticipation of this rate increase, bond yields reached 2016 highs. Chair Janet Yellen proclaimed that the Committee will enact a “measured pace” of increasing the Federal Funds rate which, in our opinion, remains supportive of future economic growth. Concerns about the potential impact of rising rates on the dollar and global financial markets are the reasons for slower rate of increases.

The U.S. economy has grown at a 2.1% annual pace over the past five years. The slow growth rate has allowed the economy to heal from the 2007-09 financial crisis. Businesses and consumers have benefitted from the low interest rate environment. Companies have refinanced debt, repurchased shares and have decent cash levels on their books. Consumers also paid down debt as evidenced by an increased savings rate. Mortgage rates remained low which encourages consumers to buy homes and consumer durables.

Other indications of the improvement in the economy are that business and consumer confidence have been rising. In December, the NFIB’s Small Business Confidence survey rose dramatically to 115.8 from 107.8 in November. Small Business owners surveyed by the NFIB reported that they intend to make capital investments, hire more people and increase wages. President Trump’s pro-growth policies such as reduced government regulation and a revamped tax code support business owners’ optimistic stance.

Yields
Strong demand for U.S. Government bonds is evidenced by the Treasury’s new issues being overbought. The Ten-year Treasury Note yields 2.36% which is above the low of 1.37% reached in the past twelve months. In fact, over the past five years the 10-year Treasury yield has traded in a 1.4% to 3.0% range. The market hints that this range may be the “new normal” implying that investment income expectations remain modest.

Stocks
Stock prices reached new highs several times in 2016 and the Dow Jones Industrial Average is flirting with 20,000. Prices are relevant in determining an investment’s value. As equity investors, we consider additional measures when weighing the outlook for the market: earnings, valuation and sentiment.

2016 earnings for S&P 500 companies are expected to be $118.01, 10% above 2015. For 2017, the consensus earnings outlook is $128.23, per Zack’s Investment Survey, an 8.7% increase. The price-to-earnings ratio base upon expected earnings, known as P/E, is a useful barometer of value. Presently the future P/E of the S&P 500 Index is at 17.7 times 2017 expected earnings, slightly above the 15.9x long-term average. We believe that on a P/E basis the market is neither expensive nor cheap. Investor sentiment has risen supported by an improved outlook for the economy. Expected earnings and sentiment measures are positive, and the P/E ratio is neutral. The 8.7% expected increase in earnings for the S&P500 Index plus the 2% dividend yield signal a good year ahead in the equity market.

When Is the Right Time to Invest?
When you are an investor and take a long-term view, any time can be the right time depending in what you are investing. Therefore, it’s advisable to have access to wealth managers who actively monitor securities and markets daily. It’s also our job to keep emotions like loss avoidance from endangering your overall goals. Investing in a portfolio diversified over different types of assets and actively managing the assets are the keys to long-term success. The secret to successful investing is to remain focused on why you invest: to build wealth over time. The Wealth Management Officers at Old Second work with clients to develop and implement investment strategies that fit their objectives of growth and income. Particularly in volatile markets, ensuring clients’ exposure to risk is appropriate for their situation remains most important. Challenges in the markets will be met with diligence and care. Our team of experienced professionals is available to help guide you along the path toward achieving your financial goals.

Rich Gartelmann CFP® – (630) 844-5730 rgartelmann@oldsecond.com
Steve Meves, CFA® – (630) 801-2217 – smeves@oldsecond.com
Jean Van Keppel CFA® – (630) 906-5489 jvankeppel@oldsecond.com
Brad Johnson CFA®, CFP® – (630) 906-5545 bjohnson@oldsecond.com
Joel Binder, SVP – (630) 844-6767 jbinder@oldsecond.com
Jacqueline Runnberg CFP® – (630) 966-2462 jrunnberg@oldsecond.com
Ed Gorenz, VP – (630) 906-5467 ejgorenz@oldsecond.com

Visit Old Second Wealth Management

Non-deposit investment products are not insured by the FDIC; not a deposit of, or guaranteed by, the bank; may lose value.

 

Outlook September 30, 2016

HAIL TO THE CHIEF

With the U.S. Presidential elections on the horizon, investors have taken a seat on the sideline awaiting the outcome. Even the Fed has decided to take a step back from their tightening initiatives to avoid any perception of political motivation. Still, this Fed remains motivated to moderate long-term interest rates with the markets pricing in a 25 basis point rate hike post-election.

It is interesting to note that in June of 2015, each the seventeen FOMC participants disclosed “their judgement of the appropriate target level for the Federal Funds rate.” For 2017, “appropriate target levels” ranged from 1% up to 3.875%, a long way off from the current target levels of 0.25% – 0.50%. What a difference a year makes! Clearly, market expectations have changed from that time and the U.S. economy has become mired in a slow growth environment.

Attempts by the Fed to increase rates have been foiled by negative headlines including the earnings recession for U.S. companies, ongoing Eurozone issues which were capped by the United Kingdom’s “BREXIT” vote in June, and escalating geopolitical concerns. Still, we must remember: “Bull markets are born in pessimism, grow in skepticism and die in euphoria.” – Sir John Templeton

Market Indicies (Total Return as of 9/30/2016)
3rdQ% YTD% 1-Year% 3-Year%* 5-Year%*
S&P 500 3.9 7.8 15.4 11.1 16.3
NASDAQ 10.0 7.2 16.5 13.6 18.7
Russell 2000 9.0 11.5 15.5 6.7 15.8
MSCI EAFE** 6.5 2.2 7.1 1.0 8.0
MSCI Emerging Markets** 9.2 16.3 17.2 0.2 3.4
Source: Bloomberg Finance L.P; *Annualized; **USD

Markets & Economic Data
The S&P 500 Index’s total return of 3.9% in the third quarter outshone the Dow Jones Industrial Average’s 2.8% total return for the period and the NASDAQ Composite sailed in with a 10.0% total return. International markets reversed course in the third quarter with the MSCI EAFE Index providing 6.5% total return for the quarter and Emerging Markets (MSCI Emerging Markets Index) posting a 9.2% total return for the period.

While the hunt for yield remains strong among investors, the high valuations of stocks in the Utility, Telecomm, and REIT sectors showed their sensitivity to an anticipated rate hike; with all three of the sectors trading down for the quarter. As of Sept. 30th, the 5-year U.S. Treasury yielded 1.15% and the 10-year yielded 1.61%.

The “risk on” trade was back in vogue with growth stocks outpacing value stocks and small-caps outpacing large-cap stocks during the quarter. As stocks can be a leading indicator for economic outlook, the third quarter results appear to be indicating that the economy is better than advertised both domestically and abroad.

U.S. economic data remains supportive of continued steady growth. While consumer data is mixed, wage growth remains steady and inflation pressures are weak. The housing sector has experienced a positive rate of growth and the outlook remains favorable. Currently, the consumer is the main source of growth for the economy. To spur GDP growth beyond the 1.5% – 2.0% range, there will need to be an increase in corporate investment or exports. The fourth source of economic growth, government spending, is not expected to increase given the current political environment.

Manufacturing in developed countries is growing as indicated by generally favorable PMI readings. The strengthening foreign economies are resulting in an improving profit outlook and favorable investment (630) 906-2000 http://www.oldsecond.com continued on back HAIL TO THE CHIEF OUTLOOK September 30, 2016 conditions. Easing concerns of a hard landing, China reported third quarter GDP growth of 6.7% year-over-year, supported by retail sales growing by 10.7% and infrastructure spending up by 19.4%.

Follow the money!
While eyes are focused on the U.S. elections and probabilities of who will be the next Commander-in-Chief; don’t lose sight of long-term investment goals. We believe that opportunities are defined by the flow of assets.

Earnings
Contracting corporate earnings for U.S. companies over the last six quarters has set the stage for the third quarter earnings season to be an important factor in determining the economic outlook for the U.S. economy. Stabilizing energy and raw material prices are likely to show that earnings in the Energy and Materials sectors are improving along with a better outlook for earnings in 2017. Consensus estimates for 2016 earnings are higher than 2015 and are anticipated to gain six percent into 2017 over 2016.

Yield & Valuation
In the current interest rate environment, higher yielding stocks and bonds have become more appealing to investors. Consequently we have seen an increase in valuation for higher dividend payers such as Utilities, REITs, MLPs and Telecoms. Additionally, the spread on low credit quality debt over Treasury debt has continued to compress below historic averages. The premium investors are paying for higher yielding securities may be a very volatile investment in consideration of the anticipated Fed tightening.

Currency
The U.S. market continues to offer superior yields on both Fixed Income and Equity investments compared to its foreign counterparts. Should this differential in rates further increase, foreign flows to the U.S. would strengthen the U.S. Dollar, negatively impacting returns on foreign investments over the short-term. Yet, over the long-term, a stronger dollar would create favorable environment for foreign companies to increase exports to the U.S.

The Wealth Management Officers at Old Second work with clients to develop and implement investment strategies that fit their objectives of growth and income. Particularly in volatile markets, ensuring clients’ exposure to risk is appropriate for their situation remains most important. Challenges in the markets will be met with diligence and care. Our team of experienced professionals is available to help guide you along the path toward achieving your financial goals.

Rich Gartelmann CFP® – (630) 844-5730 rgartelmann@oldsecond.com
Steve Meves, CFA® – (630) 801-2217 – smeves@oldsecond.com
Jean Van Keppel CFA® – (630) 906-5489 jvankeppel@oldsecond.com
Brad Johnson CFA®, CFP® – (630) 906-5545 bjohnson@oldsecond.com
Joel Binder, SVP – (630) 844-6767 jbinder@oldsecond.com
Jacqueline Runnberg CFP® – (630) 966-2462 jrunnberg@oldsecond.com
Ed Gorenz, VP – (630) 906-5467 ejgorenz@oldsecond.com

Visit Old Second Wealth Management

Non-deposit investment products are not insured by the FDIC; not a deposit of, or guaranteed by, the bank; may lose value.

 

Outlook June 30, 2016

TO LEAVE OR NOT TO LEAVE

That was the question answered by the United Kingdom in an historic referendum vote to leave the European Union. The 52% to 48% vote to “Leave” was a shock to the markets which had heavily priced in a “Remain” vote in the days leading up to it. A rise in populist sentiment against the trade and importantly the lax immigration policies enforced upon the U.K. by the European Union were the foundations of the “Brexit” movement. Upon the announcement of the voting results, extreme volatility returned to the markets after what had been a slow grind higher during the second quarter. Global stock markets cratered, interest rates dropped and currencies fluctuated wildly, following a steep drop in the British Pound (£). Equity markets quickly regained their post-Brexit losses, however, interest rates remained at their very low levels reflecting a flight to safety.

So where does the UK go from here? While it isn’t likely that elected officials would go against the will of the public, the referendum itself is not legally binding. It will be up to Parliament to invoke ‘Article 50’, which would begin the separation process. Former Prime Minister David Cameron announced his resignation, leaving the task of leading negotiations with each of the European Union nations to establish new trade agreements to the new Prime Minister Theresa May. These negotiations may take more than two years to complete. From the market’s perspective, the fact that the U.K. did not adopt the Eurodollar (€) currency is a positive. Untangling a country from a shared currency and instituting its own is a much taller task than what the U.K. and Europe are faced with now. Therefore, it is widely believed that E.U. officials will fiercely negotiate the terms of the U.K.’s exit in order to discourage other member countries from following Britain’s lead.

Markets & Economic Data

The S&P 500 earned 2.5% in the second quarter, similar to the Dow Jones 2.1% return, while the NASDAQ lagged and was -0.2%. The MSCI EAFE index was down -1.5% in the quarter, while emerging markets continued to outperform their developed counterparts in 2016 by posting a 0.8% gain (MSCI Emerging Markets Index). One theme that has continued to play out over the course of the year is investors’ hunt for yield as it simply is not available in the fixed income markets without delving into the risky high yield sector. As of June 30th, the 5 year U.S. Treasury yielded 1.00% and the 10 year yielded 1.47%.

Value stocks, in particular high dividend paying stocks, greatly outperformed their growth counterparts. Low and falling interest rates around the globe are causing investors to turn their sights to other sources of income, driving the highest yielding sectors of the stock market to lofty valuations. We believe this to be another effect of the negative interest rate policy (NIRP) adopted by the European Central Bank and the Bank of Japan. Over 30% of the world’s sovereign debt traded at a negative interest rate as of June 30. The ramifications of this NIRP experiment are still unknown although the policy has yet to bear fruit in the way of increased inflation or productivity.

Market Indicies (Total Return as of 6/30/2016)
2ndQ% YTD% 1-Year% 3-Year%* 5-Year%*
S&P 500 2.5 3.8 4.0 11.6 12.1
Dow Jones 2.1 4.3 4.5 9.0 10.4
NASDAQ (0.2) (2.6) (1.6) 13.9 13.3
Russell 2000 3.8 2.2 (6.8) 7.1 8.3
MSCI EAFE** (1.5) (4.4) (10.2) 2.1 1.7
MSCI Emerging Markets** 0.8 6.5 (11.8) (1.2) (3.5)
Source: Bloomberg Finance L.P; *Annualized; **USD

U.S. economic data has been a mixed bag and is generally supportive of slow but steady growth. Manufacturing remains a weakness, though activity picked up in the second quarter. Housing data continues to improve (benefitted by low mortgage rates), evidenced by an increasing number of home sales and prices which have risen 5.4% over the last 12 months as measured by the Case-Shiller home price index. Monthly employment reports have been choppy but the three-month average of 147,000 jobs created and the 2.6% annualized growth in wages are indicative of a still improving labor market. In addition, the more timely weekly jobless claims figures remain at low levels indicating that people who are looking for work are finding jobs. Corporate earnings are lackluster but may be poised to improve fueled by energy companies coming out of the downturn. In addition, the pause in the strengthening of the U.S. dollar should benefit U.S. multinational companies’ earnings.

Continuing to Watch Central Banks & Overseas Developments

For the time being, Janet Yellen and the Federal Reserve are on hold for increasing interest rates and it is clear that the Committee’s projection of four hikes this year made at the beginning of 2016 was far too ambitious. Adding to the confusion of market participants are the mixed messages that the members of the FOMC are sending by way of their public statements that seemingly contradict each other. In particular, St. Louis Fed President James Bullard’s abrupt shift from ‘hawk’ to ‘dove’, now favoring only one interest rate increase over the next three years after weeks earlier publicly supporting multiple hikes this year and next. Against the backdrop of slow global growth and increased uncertainty due to Brexit and the upcoming U.S. Presidential elections, we believe that the Federal Reserve will be hard pressed to justify more than one rate increase in 2016.

International central banks remain accommodative as their economies are in a continued state of low to no growth. The European Central Bank announced additional easing and is now including corporate bonds in its asset purchases, pushing the borrowing costs for some European firms to nearly 0%. Japan decided that its economy was too fragile and further delayed a sales tax increase; an action that Prime Minister Shinzo Abe had repeatedly said would only happen in the case of a major economic shock or earthquake. China mostly stayed out of the headlines and appears on track for a ‘soft landing’ with projections of around 5% growth in 2016.

The Wealth Management officers at Old Second work with clients to craft investment strategies that fit their objectives of growth and income. Particularly in volatile markets, ensuring that clients’ exposure to risk is appropriate for their situation is of the utmost importance. Challenges in the markets must be met with diligence and care. Our team of experienced professionals is available to help guide you along the path toward achieving your financial goals.

Rich Gartelmann CFP® – (630) 844-5730 rgartelmann@oldsecond.com
Jean Van Keppel CFA® – (630) 906-5489 jvankeppel@oldsecond.com
Brad Johnson CFA®, CFP® – (630) 906-5545 bjohnson@oldsecond.com
Joel Binder, SVP – (630) 844-6767 jbinder@oldsecond.com
Jacqueline Runnberg CFP® – (630) 966-2462 jrunnberg@oldsecond.com
Ed Gorenz, VP – (630) 906-5467 ejgorenz@oldsecond.com
Visit Old Second Wealth Management

Non-deposit investment products are not insured by the FDIC; not a deposit of, or guaranteed by, the bank; may lose value.

Outlook March 31, 2016

ONE QUARTER DOESN’T END THE GAME

At the March Meeting Fed Chair Janet Yellen announced that the FOMC did not increase the Fed Funds rate as was greatly expected. Reasons for holding off on the next rate rise include inflation firming at a decent pace yet below target and employment remaining steady. Chair Yellen also stated recently that “global economic and financial developments continue to pose risks” impact the pace of rate increases. Market participants showed their support for the Fed’s “Dovish” stance on monetary policy by rallying the broad stock market indices at the end of March.

Living in the modern world we are accustomed to buying foreign goods without a second thought. Coffee from South America, shoes from Italy, clothing made in China, India and Bangladesh, food from Europe, electronics from China, and the list goes on. Naturally, the FOMC is aware of the impact that US monetary policy may have on foreign economies and markets. Our Federal Reserve considers the impact on the global economy although it does not have the charge to be the monetary authority for the world.

News from abroad includes the People’s Bank of China committing to support the Renminbi in an effort to prevent a meltdown. In addition, the European Central Bank implemented a “Negative Interest Rate Policy” (NIRP) on bank deposits intending to encourage bank lending on the Continent. The NIRP as a monetary tool had been employed by the Swiss in the 1970’s, and a couple of times in the last six years by Sweden and Denmark. The impact of the NIRP on deposits of this magnitude is yet to be seen. These actions demonstrate that Central Banks are co-operating with the common purpose of maintaining global financial stability.

Leading indicators are remaining strong on a year-over-year basis, but while the news is encouraging, they do not indicate that the economy is growing at a rapid pace. Tepid is more like it. The economy has grown at about 1.3 percent per year on average over the past seven years, including a higher real growth rate of about 4% in 2014 and 2015, and slight declines on a quarter-to-quarter basis. Recent expectations of growth for the domestic GDP are near zero for the first quarter. This “soft patch” is not the same as a recession. Our research indicates that recessions in the US are typically preceded by a spike in commodity prices. Commodity price indicators remain at low levels and are well below the 2008 peaks. Consequently we believe the risk of recession remains low in the next year.

Sentiment Remains Cautious

Market participants find it difficult to look at the investment climate without using 2008 goggles. We hear from our clients that they fear a repeat of 2008. We see many bright spots in the financial landscape supporting the strength of two key segments of the economy: businesses and consumers. Housing starts and permits reported for February 2016 are more than twice levels reported in April 2009. March’s Conference Board Consumer Confidence Index is at 96.2, light years above the March 2009 low of 25.3. Consumers are nearly five times more confident about the future than they were seven years ago. Homes sales are rising, the personal savings rate is strong and the job market is good. Business activity, as indicated by the ISM, shows that the manufacturing is growing – not shrinking as it was in 2008. More than 14 million jobs have been created since the beginning of 2010. The Unemployment Rate in the U.S. hovers near 5% which we believe to be a very healthy level.

The Stock Market

The S&P500 Index dropped 9.5% between December 29, 2015 and January 15, 2016 due to concerns of a global recession. Interestingly the decline paralleled a fifteen percent drop in oil prices. Fears of an economic decline subsided and the market recovered, ending up 1.5% for the first quarter.

Reported corporate profits in 2015’s fourth quarter were weaker than anticipated capping the third quarter in a row of flat to down earnings. The outlook for the first quarter of 2016 is unappetizing as well. Two factors weighing on earnings of late include the strength in the U.S. dollar and the energy sector recession. Oil prices stabilizing recently are expected to stem the flow of red ink from energy companies by the second half of the year. Strategists estimate that S&P500 Index earnings for 2016 will be eight percent above the prior year.

March 9, 2016, marked the seventh anniversary of the beginning of the equity bull market. Stocks rose from very low values during the Great Recession to recent peaks. Easy monetary policies, low interest rates and a growing economy pushed stocks higher. The three legs of the stock market as we view them are earnings, valuation and sentiment. Earnings for companies in the S&P500 Index declined by 4.2% in the fourth quarter of 2015. Earnings were impacted by a 73% decline in energy stocks’ reported earnings and sales pressures as a result of a strong U.S. dollar. First quarter 2016 earnings are expected to rebound 25% from $23.06 fourth quarter 2015 earnings to $29.00.

Market Indicies (Total Return as of 3/31/2016)
YTD% 1-Year% 3-Year%* 5-Year%*
S&P 500 1.3 1.8 11.8 11.5
NASDAQ (2.8) 0.7 15.7 13.3
Russell 2000 (1.9) (9.8) 6.8 7.2
MSCI World ex-USA** (2.9) (7.8) 2.9 2.9
MSCI Emerging Markets** 5.7 (11.7) (4.2) (3.8)
Source: Bloomberg Finance L.P; *Annualized; **USD

Valuation as measured by the forward S&P 500 Index P/E ratio stands at 16.6x next twelve months’ earnings. The 25-year average forward P/E is 15.8x the next twelve months’ earnings. Based upon this comparison current valuations are reasonable, neither cheap nor expensive. As an indication of yields available today the 10-year treasury yields 1.7%. By comparison the S&P500 Index dividend yield is 2.2% and coupled with future growth presents an attractive alternative in those situations where risk can be tolerated for a period of time. Sentiment or investors’ feelings toward the current environment, remains difficult. Typically the Presidential election cycle is neutral with respect to market performance. It is different this time as the primary election process has become a circus of extremes, emotions and diversions from the real issues facing the U.S. today. Regrettably these emotions swamp earnings and valuations as investors determine the best places in which to invest.

Our investment philosophy begins with an analysis of our clients’ needs for growth and income. Once an Investment Objective has been determined a custom investment program is implemented and managed for our clients. A low return environment provides the back drop for our analysis and underlies our expectations for the near term. Our Wealth Management specialists are available to discuss aligning your investment program to reach your financial goals.

Rich Gartelmann CFP® – (630) 844-5730 rgartelmann@oldsecond.com
Jean Van Keppel CFA® – (630) 906-5489 jvankeppel@oldsecond.com
Brad Johnson CFA®, CFP® – (630) 906-5545 bjohnson@oldsecond.com
Joel Binder, SVP – (630) 844-6767 jbinder@oldsecond.com
Jacqueline Runnberg CFP® – (630) 966-2462 jrunnberg@oldsecond.com
Ed Gorenz, VP – (630) 906-5467 ejgorenz@oldsecond.com
Visit Old Second Wealth Management

Non-deposit investment products are not insured by the FDIC; not a deposit of, or guaranteed by, the bank; may lose value.

Outlook December 31, 2015

A Bit of Relief for Income Investors

At long last, the Federal Open Market Committee, chaired by Janet Yellen, increased the Federal Funds rate by .25% for the first time in nine years. Prior to the Great Recession of 2008-2009, the Fed Funds rate stood at 5%, but has since remained near 0% for more than six years. A .25% increase is a minor step towards normalizing interest rate levels. Highly confident that the employment and inflation indicators are nearing target levels, the Committee indicated that four increases are likely in the coming year. Taking the rise in stride, yields on money market funds and short-term bonds rose in response. Although a small move, some relief is being enjoyed by income investors.

Rocky Start to the New Year

On the heels of a frustrating and lackluster 2015, the New Year begins with a torrent of stock selling. The “crowded theater fire” selling spurred by distractions (China, oil, war mongering nations) and distortions (economic activity, strong U.S. dollars, corporate earnings) reinforces the importance of maintaining one’s investment plan despite the noise. At the time of this writing, investors are reeling from a string of 100-plus daily declines in the Dow Jones Industrial Average. We can expect increased volatility as we move forward, which is normal.

Being typical Americans, we tend to “Westernize” the rest of the world with our thinking, an interesting conversational topic but not reality. The Chinese stock market is a newer exchange dominated by inexperienced retail investors whereas U.S. stocks are traded largely by professional investors. The panic seizing the U.S. markets appears to be a reaction to the sell-offs overseas and the intentional devaluing of the Renminbi (RMB). Getting out of the way of a herd of cattle is nearly impossible, however cattle do eventually tire and the cowboys round them up.

While Chinese financial markets do not govern our investment strategies, we believe that it is important to discuss what happened. A couple of factors collided to create the panic selling in Chinese stocks. Government imposed sanctions on selling Chinese A-shares enacted last summer were lifted in January 2016. Also, China experienced capital outflows at the end of 2015, possibly fueled by the weakening RMB, and there was weaker than expected economic news for December. The lack of transparency around their policymakers’ priorities adds to the challenges facing China.

The intentional devaluation of the RMB in mid- and late-2015 comes after a nearly thirty percent appreciation of the currency over the past five years (Source: Bank for International Settlements). Facing an economy growing at seven percent, a decent clip albeit slower than the past decade or so for China, the People’s Bank of China’s move to lower the relative value of the RMB may be an attempt to stimulate economic growth. Over the longer term, the currency moves will have a broader impact on their economy than the changes in U.S. domestic stock prices.

U.S. Financial Market Review

U.S. Treasuries yields ended the year at levels near their yields at the beginning of the year. Slow and steady growth in the U.S. economy, which is good for financial assets, was overtaken by global concerns. Oil prices fizzled from $53 to $37 during the year as supply swamped global demand. Energy stocks and bond yields suffered as a consequence. One apparent goal of the Middle East oil producing countries by opening the well spicket wide is to drive out the high cost oil producers in the United States. The tactic may be working as the number of oil wells operating in the U.S. contracted two-thirds during 2015.

Amidst the chaos in the financial markets, there are reasons to be cautiously optimistic going forward. On a national level, the housing recovery absorbed many workers who were displaced by the capping of the oil wells. Consumers are benefitting from significantly lower prices at the pump, essentially getting a tax cut and a raise eventually. Representing more than sixty percent of our economy, consumers are a powerful force who will spend that savings, adding stimulus to the economy. The Federal Budget, passed in December, includes a stimulus package that could add over .2% to GDP growth in 2016. Commercial and industrial loan volume rose eleven percent in the 52-weeks ended 12/23/15 indicating strength in the economy and banks’ willingness to lend.

One of the subtleties one must recognize is that the U.S. is becoming the “old reliable” one, rather that the young, adventurous one. We can all relate to someone we know who is financially responsible, conservative, available in times of need, dedicated, and thus may be a bit boring. The U.S. economy, growing at two percent, may be a bit boring as well, but it is our longer term reality. Construction activity is slowly increasing, providing job opportunities. The current unemployment rate of five percent and rising wages bode well for this slow economic back drop. Our take away is that the U.S. economy will muddle along supported by accommodative monetary policy, Federal incentives and a strong consumer sector. Even a boring economy can be a good one. Translating the economic optimism into a quality-focused 2016 outlook remains our theme. Index Returns as of December 31, 2015:

Market Indicies (Total Return as of 6/30/2015)
YTD% 3-Year% 5-Year%*
Dow Jones 0.2 12.7 11.3
NASDAQ 7.1 19.9 15.0
S&P 500 1.4 15.1 12.5
Russell 2000 (4.4) 11.7 9.2
MSCI World ex-USA** (0.2) 5.7 4.3
MSCI Emerging Markets** (14.8) (6.5) (4.5)
Source: Bloomberg Finance L.P; *Annualized; **USD

Looking at the numbers, the S&P500 Index returned 1.4% for the year ended December 31, 2015. Separately the four “FANG” stocks: Facebook, Amazon, NetFlix and Google, returned an astounding 83% for the same period. The internet “darlings” commanded huge returns as investors followed “hot money”. On the flip side stocks in the Energy sector declined more than twenty percent in the year demonstrating the bifurcated nature of the market last year.

We believe the three underpinnings to the stock market are earnings, valuation and sentiment. U.S. corporations having faced headwinds caused by the strong U.S. dollar and energy company earnings drag are expecting an earnings recovery in 2016. Earnings are expected to be $118.73 for 2015, and $127.21 for 2016, a seven percent increase according to the folks at Zacks Investment Research. Valuations have become more attractive in the recent contraction. Two of the three tenets of the stock market are favorable. Sentiment remains a challenge as volatility increases in the market.

Investment quality and suitability remain foremost in our investment strategy. A diversified portfolio of quality investments tailored to your individual situation will deliver good returns over time. Thank you for allowing the Old Second Wealth Management team to be of service. Please contact a member of the Wealth Management Department if you have any questions about this information.

Rich Gartelmann CFP® – (630) 844-5730 rgartelmann@oldsecond.com
Jean Van Keppel CFA® – (630) 906-5489 jvankeppel@oldsecond.com
Brad Johnson CFA®, CFP® – (630) 906-5545 bjohnson@oldsecond.com
Joel Binder, SVP – (630) 844-6767 jbinder@oldsecond.com
Jacqueline Runnberg CFP® – (630) 966-2462 jrunnberg@oldsecond.com
Tamara Wiley, CFP® – (630) 844-3222 twiley@oldsecond.com
Ed Gorenz, VP – (630) 906-5467 ejgorenz@oldsecond.com
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Non-deposit investment products are not insured by the FDIC; not a deposit of, or guaranteed by, the bank; may lose value.