The Dow Jones plunged 450 points early Monday, before moving up somewhat in later trading. Still, the three major markets were poised to end the first trading day of 2016 down by more than 2 percent.
Also on Monday, a group of experts with Janus Capital Group and its affiliates released their views on the year ahead — including a breakdown of the many factors likely to drive volatility in the fixed income and other sectors in 2016.
“While opportunities for generating positive returns exist, we continue to monitor potential risks of which investors must be cognizant heading into 2016. Many of the causes of last summer’s spike in equity market volatility are still present,” Janus explained in its “Janus Market GPS 2016” report.
Among these is the recent trend of stagnating corporate earnings, the group said.
“Much of the earnings growth during the post-crisis era has been propelled by streamlined operations,” it explained. “With companies running lean, revenue growth is needed to support further gains in the bottom line … [which] has been lacking and is a troublesome trend.”
Greg Kolb, CIO of Perkins Investment Management said the increase in highly leveraged balance sheets is exacerbating lean sales growth.
In the energy sector, for instance, expansion in drilling was financed by borrowing, and this makes those with high leverage ratios “especially vulnerable to chronically lower crude oil prices,” he added.
In general, Kolb explained, companies that are “levered up to the gills” have to repay creditors, and this gives them “less financial wiggle room” — a big challenge for management under pressure to boost both sales and earnings.
Fixed income issues
According to Gibson Smith, chief investment officer of the Janus Fixed Income Fund, the mix of stretched valuations and low returns “by definition, leads to higher volatility.” Likewise, their extended durations puts Treasurys at risk.
“The combination of historically low yields and long durations means that impending rate hikes will likely result in material losses, as meager coupon payments are insufficient to compensate for declining Treasury prices.”
There’s also the risk of “Fed error,” according to Smith.
“The Fed’s impending tightening cycle is the first of its kind as it comes with wage growth that is generally stagnant, inflation showing no signs of increasing, and the Institute for Supply Management’s activity index slipping below the ‘boom-or-bust’ mark of 50 in November, thereby pointing to a marked slowdown in manufacturing activity,” he said.
Seth Meyer, a portfolio manager and analyst at Janus, intends to watch the long end of the yield curve, since “signficant flattening” during the tightening cycle may signal that the markets “fear the Fed may be tightening at the wrorng time in the cycle,” he said.
Dividends, growth stocks
The complex economic picture gives investors and advisors watching the dividend-paying stock sector plenty to do this year, according to Janus portfolio manager March Pinto.
“I don’t think interest rates are back to the races,” he explained. “Gradually rising rates with a renewed economy and a whiff of inflation is a good backdrop for equities and for growth stocks in particular,” he stated.
Nonethless, investors need to carefully monitor dividend-paying equities.
“A rising interest rate environment can separate the performance of companies growing their dividends versus those that just pay a high but static dividend,” Pinto noted.