Navigating The Markets In 2016

Stocks closed out last year with a small loss and 2015 went down in the books as the worst year since 2008. Even though the S&P 500 only fell by 0.7%, it felt much worse for the average investor. Individual stocks and sector ETFs struggled as the easy money in the bull market is more difficult to identify. That being said, there are a lot of reasons to remain bullish on U.S. stocks for 2016 and beyond.

A snapshot of the first week of trading in the U.S. stock market would suggest investors partied a little too hard on New Year’s Eve. By Friday the S&P 500 had already dropped by over 5% in 2016—the worst start ever to a year! On top of the 2016 struggles, the Dow and NASDAQ also moved into correction territory, defined by a 10% pullback. This is significant because until August of last year the major indices had not experienced a correction in over four years.

Why Are Stocks Falling?

The headline of every newspaper, website, etc. will have you believe the reason for the stock market sell-off is the economic numbers out of China. That is the easy answer to a more complicated question. Granted, the Chinese stock market triggering circuit breakers with 7% losses two times in one week is significant. But we need to look at why the Chinese stock market crashed.

The Chinese economy is slowing, but it has been slowing for over a year and it is not as if investors woke up after partying for the New Year and took notice. Selling was exacerbated by the fact the Chinese government was devaluing the Yuan in attempts to increase exports. A very similar action took place in August 2015, sending the Chinese stock market into a bear market and U.S. stocks into their first correction in over four years.

There are other stories that could be more worrisome to investors who are already ready to jump off the stock-market train. The geopolitical situation has been a bigger concern since the Paris attacks, and the New Year kicked off with two headlines I felt were a bigger reason for the global stock sell-off. First the tensions between Iran and Saudi Arabia are heating up and nobody around the globe wants to see an escalation between the two long-term rivals.

Then there is North Korea who has claimed to have successfully tested a hydrogen bomb. Most experts question the reports out of the small dictatorship that the bomb was successful. Whether it was or not may never be known; what is known is that the report adds fear to investors who are already scared of their own shadows.

Diversification Is Key

The fear-mongering so-called “experts” are taking their short-lived time in the media as they tout the coming of the next apocalypse. Everything from gold to buying land in Bolivia will be thrown at investors as a strategy to escape the inevitable death of the stock market. Last time I checked, the 130-year chart of the U.S. stock market moves in one clear direction – up!

During times of panic selling, it is difficult to find a sector or asset class that will completely avoid the scared investors who are hitting the sell button. The gold bugs will argue that the precious metal is the best safe haven investment in the market. They may be correct for a week or two, but the chart of the price of gold shows a distinct downtrend since 2011. Gold is down over 40% from its highs and during the same time the S&P 500 is up over 70%. The numbers do not lie—gold has been a losing bet as a safe haven for five years.

The key is not to shift a portfolio to safe-haven investments, but rather to have a diversified portfolio during a time when corrections are more likely. Attempting to time the market by rebalancing a portfolio from week to week is not as easy as it is on paper or as the late night infomercials will lead you to believe.

The yield on U.S. Treasuries remains well below historical levels even though the Fed has begun its rate-hike cycle. Therefore, companies with stable balance sheets and solid dividends will be considered safe havens during a market correction.

The water utilities are a niche group that I feel are the best positioned during a pullback as well as a market rebound. There are only a few companies traded on major exchanges and they typically have a beta below 0.50, suggesting they have little correlation to the S&P 500.

One example is small-cap Connecticut Water Service (CTWS), which has a beta of 0.2 and a dividend yield of 2.8%. Even more impressive is the fact the stock is beating the market by 800 basis points in the first week of trading.

Another strategy is to search for stocks that were able to outperform during the last bear market. In 2008 the S&P 500 lost 38.5% and nearly every stock in the index was down for the year, except Wal-Mart (WMT). The country’s largest retailer closed out 2008 with a gain as investors assumed a terrible economy would mean every American would be shopping at Wal-Mart, looking to save money.

Could the same thought process be going through the minds of investors again? The mega-cap retailer is up over 5% through the first week of 2016, beating the S&P 500 by approximately 10%.

Stay The Course

Since the beginning of the bull market in March 2009 there have been 19 pullbacks of at least 5% in the S&P 500. The pullbacks ranged from 5.1% to 21.6%. The market last topped out on November 3 and since that time the index is down 8.4%, which just happens to be the median decline of the 19 occurrences. All signs are indicating the current stock market pullback is a garden-variety correction, nothing less, nothing more.

Another way to look at the big picture is by examining how investors are affected by missing out on the best single-day gains in the stock market. Since 1985, investors who followed the buy-and-hold strategy with the S&P 500 have gained 8.4% annually. If an investor missed the best five days in the stock market over the last 30 years it would lower the annual return on the portfolio to 6.69%; missing the best 25 days takes the annual gain to 3.06%.

It is unlikely that investors would miss the 25 best days, but the reason this is significant has to do with when the best days occur. A sharp sell-off in stocks is often followed by a snapback rally that turns out to be some of the best one-day gains for the market. When investors panic-sell, they miss the snapback rally and thus lower their long-term gains.

The bottom line is that investors need to stay the course and think big picture. An old-timer on Wall Street once told me that every day you wake up there are numerous reasons not to be invested in the stock market. Considering the stock market has been the number one wealth creator for the average American for over a century, please put your fear aside.

Matt McCall, founder of Penn Financial Group, an investment advisory group serving individual and institutional clients from coast to coast. Author of two best selling books, “The Next Great Bull Market” and “The Swing Trader’s Bible”. Regular guest on Fox News Channel, Fox Business Network, CNN, and GBTV with over 1000 TV segments in the last 5 years. Writing contributor for the International Business Times, The Blaze, Benzinga, and Index Universe.