Investing in Utility Stocks

Those who read my post from early January, "What's Working in this Market Correction", will know I favor utility stocks in the current market.  In fact, the utility ETF, XLU rose from 43 on January 4 to 50 on March 28, or a gain of 16% in 12 weeks.  It's since backed off, now trading at 48.  I'll explain why in a moment.  First, why I like utility stocks and what their performance this year says about the economy.

XLU

Utility stocks essentially trade like bonds.  Known for consistent and high dividends, investors buy utility stocks as they would fixed income securities, for their predictable level of dividend payments.  The dividend yield, or the relationship between the annual dividend and the stock price, is often equated to a bond yield for more traditional fixed income securities.  Utility stocks are not pure dividend plays, though, and we'll get to this issue in a moment, as well.

Trading like bonds, of course, means that price and yield vary inversely.  As interest rates rise, the price of bonds and utility stocks decline.  As rates decline, utility stocks tend to appreciate. Over the past two months, since the lows of the stock market in February, stocks have rallied following a risk on momentum trade.  Bonds have weakened.  The US 10-year has traded as low as 1.63% and as high as a 1.97% over this period.  

If this risk on rally that has been leading momentum into the least favored sectors of the market is about to turn once again, however, the focus will shift back to the continued weakness in GDP, consumer spending, capital investment, durable goods orders, commodity prices and corporate earnings.  This perceived weakness will damage stocks, but boost fixed income securities that rally in the face of low growth and inflation.

This being said, while factors favor utility stocks, I don't prefer the ETF alternatives, and here's why.  Utility stocks largely trade like bonds, but not entirely.  Their values also swing based upon forecasted revenue on energy sales to their customer base.  In some regions of the country, that customer base can be heavily industrial, for instance Texas, Oklahoma and much of the mid-west.  If the economy is in fact slowing, industries in these regions will likely reduce their consumption of power, impacting utility revenues.

Residential demand for power, on the other hand, is highly stable and far less impacted by economic cycles.  For this reason, better opportunities present themselves in utilities with higher residential customer profiles, than what might be achievable with the XLU.  A few large utilities that fit this profile and should be considered are Duke (DUK) with 6.2 million of its total customer base of 7.2 million being residential, Southern (S0) and Exelon (EXC).

San Bernardino's Pension Fiasco

New details emerged this week on the City of San Bernardino's bankruptcy recovery plan. Reuters reported a proposed settlement with two of the creditors of the city's 2005 pension obligation bonds. That plan calls for bondholders to write off as much as 60%, or $30 million of their original $50 million investment. 

The bonds in question were originally issued by the City back in 2005 to help shore up the city's struggling public employee pension fund, held by the California Public Employee Retirement System, or CalPERS.  Unable to come up with the funds to fulfill its commitment to retirees, the city turned to the public bond markets, selling bonds and using the proceeds to pay CalPERS. In being granted authorization under law to issue the pension bonds in 2005, the city obtained a court ruling confirming that the city wasn't issuing new debt, per se, but rather refinancing debt it owed to the CalPERS pension fund.

By July 2012, though, soon after it filed for bankruptcy, the city failed to make required semi-annual payments on the bonds, throwing the bonds into default.  Interestingly, in its bankruptcy filing, the city blamed the high costs of its fire and police labor contracts, including pensions as the main issue forcing the bankruptcy filing. Now in bankruptcy, the city failed to make payments on the bonds funding that pension liability, as well.

The two principal holders/guarantors of the bonds sued the city soon thereafter, arguing that the bonds should be paid on an equal basis with the city's continuing obligations to fund its pension account at CalPERS.  But in the end, the powerful, $300 billion CalPERS prevailed in court. In May 2015, a bankruptcy judge threw out the bondholder suit, allowing the city to proceed with its plan to make pension payments to retirees in full, while forcing bondholders to suffer significant losses on their loan to the city.

Now let's step back here a moment and take a look at what has actually transpired.  The city, through negotiation with its employee unions, had agreed to make a certain level of lifetime pension payments to retired city employees. Unable to come up with the funds from tax revenues and other sources to do so, the city borrowed $50 million from investors. It deposited these funds with CalPERS, the pension trustee, on the city's behalf.  

Now, in cramming down a loss of $30 million (or 60%) to bondholders, the city is arguing that it doesn't have the funds to make full repayment. However, it actually does. The full $50 million that the city borrowed, plus interest, remains on deposit in the city's pension account with CalPERS. So, in effect, what has happened is that the city effectively stole $30 million from investors (the difference between the original borrowing and the amount to be repaid) using the money to make whole on its pension commitment to employees.

Now, here is where this gets truly galling. As reported in our blog from May 2015, a study of salaries of the 120 highest paid firefighters in San Bernardino reported by Bloomberg shows the top one-third drawing an average salary of $190,000 per year; the next third $166,000 (this is in a city where the median household income is $52,112 per year). In retirement, as early as age 50, these firefighters may be eligible for annual pensions of up to $171,000 per year, an obligation the city will need to pay for many years to come. This might, in part, explain the types of management decisions that led up to the city's bankruptcy and its nearly unconscionable deal with its bondholders.

Much more on the public pension and retirement crisis can be found in my new book: Up In Smoke: How the Retirement Crisis Shattered the American Dream, available on Amazon.com. 

The Dash For Trash in Stocks

Following an unusually rough start to 2016, the last four weeks have seen a dramatic turn of events in stocks, oil and commodity prices. The question we ask is "what has changed?" Unfortunately, not very much. Our concerns entering 2016 are still with us: record low commodity prices, weak oil, widening junk bond yields, declining corporate profits and a less accommodative Fed.  These concerns are superimposed upon a bleak macroeconomic picture, with many starlets of the emerging markets stumbling, including China, and others falling hard, like Brazil.

Amidst this backdrop the rally in stocks has been puzzling. Driving these gains, in part, was a race to hastily cover short positions in oil, as a rumored OPEC alumnae reunion quickly sent the price of oil up by 50%.  Oil analysts, though, shrug off the effect of a plan to freeze production at today's record levels (even assuming parties would hold to it) as having little impact on ever-growing inventories.  However, as weak shorts run to cover in oil and beaten down oil stocks, hedge funds and algorithmic traders have been quick to ride the tailcoats of all the buying.

But let's look at one non-oil, non-mining blue chip stock to see what has happened to valuations over the past several weeks. Boeing Corp (BA) bounded off its mid-February lows of 108, to now trade at a robust 130.  Little has actually changed at the company over this period. In fact, the company announced in late February that it would be laying off employees, including highly paid engineers, as it faces stiff competitive market pressures, principally from Airbus. This news followed a downbeat earnings report for 2015 Q2, released on January 27, in which the company lowered forward earnings guidance on an expectation of slower 2016 sales. Boeing's net in 2015 Q4, it turns out, was $1.03 billion, down from $1.47 billion in the same quarter a year earlier. 

Yet despite this 29% drop in Q4 earnings and lowered guidance for 2016, Boeing stock is up a stunning 20% from its February 11 low.  So how is this possible?  Multiple expansion. Today, BA trades at 17.15x twelve month trailing earnings, above its 5-year historical range of 16.19x. But with earnings projected to decline, even if not nearly to the degree the company experienced in 2015 Q4, this TTM multiple will jump significantly, without any further gain in the price of its stock.

Now this isn't to say that Boeing is a weak or troubled company. It is an outstanding company, with excellent long term prospects. But these prospects must be set against global macroeconomic conditions that support, or in this case, limit growth. This issue, in fact, is precisely what the company warned in its Q4 earnings statement.

Meanwhile far trashier stocks, like Chesapeake Energy (CHK) are up 201% over the past four weeks, while Freeport McMoran (FXC) is up 187%.  It's much more difficult to value these stocks on a TTM p/e basis, because these stocks do not have earnings.  Not by a long shot. FXC lost $12.2 billion in fiscal 2015. If you think this might give pause to the reasonableness of a 187% rise in FXC's stock price, you might want to consider treading cautiously in this newfound market rally.

The Rising Mountain of New Jersey Pension Debt

This week, the Supreme Court of the United States moved to uphold a 2015 ruling of the New Jersey Supreme Court, thereby defeating a challenge to the state's plan of pension funding brought by public employee labor unions. The unions sued the state over the underfunding of the state's staggering employee pension deficit. The unions alleged that in 2014 Governor Christie failed to fund the plan at an agreed upon level, per a deal negotiated by state legislators and the unions in 2011.

To understand where this story begins, or just how dire the circumstances are surrounding the New Jersey Public Employees Pension Fund, a bit of background is required. In 2014, the State of New Jersey deposited roughly $700 million of taxpayer dollars into its employee pension fund. The State spent an additional $2.8 billion of public monies to fund retiree health care benefits. Yet, despite these significant investments in shoring up the retirement plan of its past and current employees, the State actually underfunded its statutory funding obligations by nearly $3 billion.

To understand how this is possible, we need to delve into the murky world of state and local government accounting. To fully fund the state's requirements, simply to keep pace with current pension costs - with no effort to catch up on past underfunding - would have required the State of New Jersey to contribute $6.5 billion of taxpayer funds, or 20% of the entire state budget to its pension funds. So the state "saved" $3 billion by underfunding in 2014. But year after year of these kinds of "savings" or deferrals, simply builds one heck of a mountain of debt, or pension liabilities, for the state (or more specifically, taxpayers) to climb in the future. In fact, by 2015, New Jersey's total benefits liabilities had reached a staggering $90 billion - $37 billion in unfunded pension liabilities and $53 billion in unfunded health benefits.

Now back to the Supreme Court. The case revolved around the agreement negotiated in 2011. In order to gain concessions from the unions on greater employee pension contributions, the state agreed to gradually increase its funding of pension contributions in each year, until reaching the required annual level. And in fact, things proceeded just this way in 2012 and 2013.  But in 2014, in an effort to pass a strained budget, the state reduced its annual pension contribution by the aforementioned $3 billion. Governor Christie claimed financial hardship. The unions sued saying the stated had breached its 2011 deal. The Supreme Court has now sided with the state, allowing the State of New Jersey further leeway in kicking the can down the road on its pension obligations.

Looking ahead, for the state's fiscal year 2017 beginning on July 1, the Governor has proposed $1.86 billion in pension contribution, or just 40% of its required annual contribution. And while this may help the state balance its 2017 budget, the state's pension mountain continues to rise before New Jersey public employees and cast an ever-greater shadow over its taxpayers.

Much more on the public pension and retirement crisis can be found in my new book: Up In Smoke: How the Retirement Crisis Shattered the American Dream, available on Amazon.com. 

Retail Spending and the Consumer

I had lunch recently with a friend in a fashionable urban restaurant. When the conversation came around to the economy he said, just look around. Everywhere I go restaurants and retail shops are crowded with people eager to spend. From Fifth Avenue to Rodeo Drive. From San Francisco to Miami Beach, restaurants are crowded and consumers are spending, spending, spending.

The problem with this image, of course, is consumer behavior in these tony high end locations tells us very little about the overall health of the American consumer. How little, may be just 1%. 

For the month of January, total retail sales grew by 0.2% over the prior month. These weak results were at least partially due to falling gas prices - a good thing for consumers. Retail sales ex-auto, gasoline, building materials and food services (i.e., core retail sales) were up 0.6%. While not stellar, the January report followed an outright decline in core retail sales of 0.3% in December. Not great, but certainly not recessionary. Bear in mind also that retail sales figures are not adjusted for inflation. So 2% sales growth in an economy with 2% inflation, would mean essentially flat unit sales. 

Against this backdrop, consider that four states are already officially in a downturn, as reported by Bloomberg News: Alaska, North Dakota, West Virginia and Wyoming. Likewise, other states are threatened, as well, including Louisiana, New Mexico and Oklahoma, according to Moody’s Investors Service. And of course there is Texas, which is also struggling with plunging oil prices, layoffs and reduced consumer spending.

So what's going on? Fortunately, the Commerce Department, in its monthly report of consumer spending, gives us a broader view of how people are spending, or not spending. If we drill down into the January Retail Sales Report, here's what we find beneath the headlines. On a year over year basis, food and beverage store sales were up just 1% (the CPI in January on a year over year basis was up 1.4% so sales grew by an amount less than inflation). But sales at bars and restaurants were up a solid 5.4%, indicating a preference for meals out to those at home for many consumers. Yet, furniture and home furnishings grew by just 1.4% (about the rate of inflation) while clothing stores were flat (no increase in sales, before inflation). And department store sales fell 4.5%, while electronics stores were off 5.4%.

So while the anecdotal evidence of a healthy consumer eating out more often and buying lavish clothes may be what some of us see, others see a far more bleak picture of retail spending, lending yet further support to the case for an impending recession.

How to Spike Your Pension

When Marty Robinson was elected Chief Executive of Ventura County, California in 2008 supporters cheered her appointment. A councilwoman from the Ventura County city of Oxnard claimed, “That’s a glass ceiling broken”. At her retirement ceremony in 2011, her colleagues offered tributes that lasted nearly two hours. The Board of Supervisors renamed a stretch of the County Hall of Administration, “The Marty Robinson Trail”. Ms. Robinson’s compensation that final year? She was paid a total of $330,000.  

Startling as this may be for a public servant, this level also forms the basis by which her lifelong pension payments will be calculated. Her highest year compensation of $330,000 entitles Ms. Robinson to lifetime annual retirement benefits of $272,000, an amount it turns out, that is actually higher than her base salary for the year of $228,000.  By adding unused vacation time, overtime, car allowances and other perks, Ms. Robinson was able to significantly raise (or "spike") her final year compensation as the basis for all future pension benefits she will receive in her retirement. While this practice was outlawed by the California Public Employees Retirement System (CalPERS) in 1999, counties like Ventura who do not participate in CalPERS, but rather manage their own internal employee retirement systems are free to allow the practice to continue. In fact, twenty of the state’s fifty-eight counties run pension plans that are outside of this CalPERS mandate, following a 1937 law that granted counties a choice between joining the statewide retirement system and creating their own. These twenty counties, known as 37 Act counties, are not required to follow mandates of CalPERS or other statewide directives.

Assuming Ms. Robinson lives to age 85 and the CPI averages three percent over the next twenty years, Ms. Robinson will receive total retirement benefits from Ventura County of $15,702,608 (or $24,221,167 should she live to age ninety-five).  Now here’s where it gets interesting.  Had she not tried to manipulate the system by spiking her final year income - artificially boosting her salary in the manner described above - her total retirement benefits to age eighty-five would still have totaled $10,849,000, placing her in the top 0.01% of retirees.  

Sadly for us, as taxpayers, Ms. Robinson is not alone. Despite a $761 million unfunded pension liability for Ventura County, 84% of its retired county employees earning more than $100,000 per year pre-retirement saw higher income in retirement than they did as employees on the job. The former Ventura County Sheriff is reportedly receiving $272,000 per year in retirement pay (twenty percent higher than his salary) while the former county Undersheriff is receiving $257,997, a full thirty percent above his base due to spiking.

Following these and other alarming details of the Ventura County retirement system, a measure was placed on the November 2014 ballot called the Sustainable Retirement System Initiative, designed to stop these and other abuses. Among other reforms, the Sustainable Retirement System Initiative would shift new county employees to a 401(k) style defined contribution retirement plan, thereby relieving county taxpayers of future pension liability for these employees. Proponents argued that the measure could save county taxpayers millions. 

A group backed by the Ventura county employee unions quickly sued, however, arguing that if such a measure were to be approved, the county would face great difficulty in recruiting new employees (i.e., if their benefits more closely resembled those of private sector employees). Before taxpayers could have a say one way or the other, on August 4, 2014, Ventura County Superior Court Judge Kent Kellegrew ordered the item be removed from the ballot, thus denying taxpayers an opportunity to vote on the proposal. One last thing in case you are wondering. Yes, County judges are covered by the same Ventura County pension plan.

Much more on the public pension and retirement crisis can be found in my new book: Up In Smoke: How the Retirement Crisis Shattered the American Dream, available on Amazon.com. 

Next Bubble to Burst

Many today believe the 2008-2009 recession was caused by a credit crisis in the banking system. They view the levels of debt that had built up in the consumer and financial sectors as excessive and somehow "blowing up" like a form of spontaneous combustion. The credit crisis, however, was preceded by a number of developments, not the least of which was the vast expansion of debt and the instruments that created and compounded that debt. But, the most immediate precursor of the crisis was a sudden and rapid repricing of risk that was well underway by the middle of 2007. In the years prior to 2007, risk had largely been discounted in the corporate, financial and consumer sectors, as yield spreads narrowed to historic lows. By 2014-2105, junk bonds were trading at yield levels below that of high grade corporate bonds throughout much of the 1990s.

Credit spreads, or the yield differential of a corporate bond, mortgage security or other debt instrument, relative to the US Treasury benchmark rate, is at the center of the way in which bonds are priced in the capital markets. The lower the credit rating, or the higher the perceived riskiness of a bond, the greater the yield spread relative to a Treasury bond of equivalent maturity.

Now the thing is, credit spreads are not static, but rather vary from time to time. During periods of relative calm and optimism in the financial markets, credit spreads tend to compress (often just as lending criteria become more relaxed). In times of uncertainty or distress, credit spreads widen. In the period 2003-2007, high yield bond spreads declined to levels that were absurd, with junk bond spreads compressing to less than 2.5%. By the time the 2008 recession was fully underway, however, these spreads would widen to an all-time high of 21.0%!

As can be seen from the graph below, debt levels are now once again at record levels, although today the debt is concentrated in the corporate and sovereign sectors, rather than the mortgage and financial sectors, as was the case leading up to the financial crisis. In fact, absolute debt levels in the US today are much higher than they were before the 2008 financial crisis.

Amidst this expansion of debt, a similar pattern of ultra-low risk premiums has been underway for several years, as a rapid expansion of liquidity by world central banks flowed into the sector. By mid-2014, high yield credit spreads had fallen to 3.3%. But now, the tide is once again turning. Rapidly widening credit spreads for high yield bonds are again underway, showing a similar pattern of risk re-repricing to what we saw in 2007. Today, the high yield index shows a credit spread of just under 8.0% (roughly the same levels as 2008).

The near default in Venezuela, deepening recession in Brazil and devastation in the energy sector has us also wondering about the vulnerability of bank stocks, with material emerging markets and oil patch exposures for these institutions. If the value of publicly held high yield debt is rapidly deteriorating (as price moves inversely with yield) mustn't the same value deterioration be equally true of these bank loans?  JPM Chairman, Jamie Dimon was quick to play down the issue of his bank's risk profile in energy, arguing that the bank is well reserved against potential losses. As if to further comfort JPM investors, Dimon continued to offer that bank loans to oil and gas companies are asset backed; that is, losses would be offset by the realization of collateral.

The question, of course, remains as to what these assets would be worth in an environment of plunging oil prices, record excess capacity and massive inventory build. Taken in the context of the repricing of risk, the high yield bond market does appear to be telling us something about the near-term future of the economy that is increasingly difficult to ignore.

Hillary Clinton's Plan for Social Security

Faced with increasing pressure from Bernie Sanders for the Democratic nomination, the Clinton camp has recently found it necessary to finally address the issue of Social Security, a topic widely discussed by Senator Sanders. We've written at length about the issues facing Social Security, as well as the flaws in Bernie Sanders' well-intentioned plan for revitalizing this program, upon which so seniors widely rely.

Ms. Clinton's proposal, however, not only lacks substance, but credibility. After all, in previous mention of the topic, her comments have been limited to "don't touch it". Then, as now, not touching Social Security puts us on a path to the program's demise. This is not our view, but that of the Trustees of the Social Security Administration. And lest you believe as Ms. Clinton proclaims that the whole idea of Social Security insolvency is a myth promoted by the GOP, consider that the Trustees of the Social Security Administration, the same ones attempting to alert the public to the impending disaster, are all Obama appointees - and all Democrats.

Clinton's plan to fix Social Security is, first, to kill the notion of privatizing the system. Well, she may be right about this, but killing a proposal hardly provides a fix. Second, she'd "consider" raising the cap on wages subject to the Social Security tax (currently $118,500 per year). Lastly, she'd like to make some sort of adjustment for women, seeing that women often work less years than men, and therefore accrue less Social Security benefits. And, sorry folks, that's about it.

Just to recast the problem, quoting the 2015 report of the Social Security Administration, the present value deficit of the Social Security Trust Fund, in other words, the difference between what is projected to be paid in benefits and what is expected to be gathered in taxes and investment income, is roughly $10 trillion. Removing the cap on wages alone (which goes somewhat beyond what the candidate has proposed) is a relative drop in the bucket. And this is the only aspect of her plan that can actually be quantified.

Here's the basic problem. With an aging society and demographic imbalances, the current level of tax and earnings will only float the Trust Fund until 2034, or roughly another 20 years. After that, benefits, already meager, would have to be reduced by a third. Now here's the tough part, There are only two possible solutions for addressing this crisis: either increase taxes, or cut benefits, or provide some combination of the two. The subtlety comes in how this is done. How do you raise taxes fairly and keep from cutting benefits to those who need them the most? For this, we've previously provided our views, available here.

What's Working in this Market Correction

The New Year starts with a bang, with hundred points swings in the Dow Jones Industrial Average each day this week. Unfortunately, the swings have all been to the downside, with the S&P falling nearly 5.0% this week. In this environment, investors may be tempted to throw up their hands and sell everything, or watch from the sidelines like a deer in the headlights as portfolio values head ever lower. Let's look at what's actually working.

First, while some portion of the selloff was likely initiated by the Fed's modest rate hike in December, the 0.25% increase has all been directed at the short end of the yield curve. Bonds, especially long-dated bonds have performed quite well, with the yield on the 30-year UST falling below 3% (2.93% as of this writing) from a level of 3.04% just last week. Eleven basis points of declining yield has the price of the US Treasury 2x ETF (UBT) rising from $73 to $76 over the same period. That's a 4% gain for the week, while everything else seems to be swimming furiously in a sea of red.

This leads us to our first trade for the New Year, bonds, and specifically UBT as an ETF play available to retail investors. UBT is levered 2x which means that a rise in long term interest rates would also cause this instrument to fall disproportionately in value. But if your view is that the economy may be hitting a rough patch, where stocks are susceptible, then bonds may provide a safe port in the storm. This is especially true if you believe economic growth and inflation, the principal enemies of bonds, will continue to be subdued. It's also worth noting that UBT traded as high as 97 back in February 2015, when the long bond traded at 2.25%. Not to say this is where things are headed, but with the softness we're seeing in global markets, difficult to rule it out either.

Oil continues its rapid decline, now bordering on a free-fall. The inverse leveraged ETF, SCO, has done especially well over this period, rising from $80 in the beginning of November to its present level of $160. How much lower oil can go is anyone's guess, but WTI is now roughly where it was during the 2009 recession (along with other commodity prices). Hard to believe it falls much further, yet SCO may still form a reasonable hedge against long positions, certainly in energy and perhaps, also, industrial stocks.

SKF, the inverse leveraged ETF on financial services stocks, also has our attention. This instrument can not only provide a hedge against other long equity positions, but highlight the risks specific to the financial services sector. Some concern with financial services profits may be warranted following the poor performance of markets in the latter part of 2015 and the disastrous 4th quarter results posted by Jefferies on December 15. Customarily a harbinger of things to come at the larger Wall Street names, our concern can only be amplified by the exposures of these firms to deteriorating credits in the oil patch.

On the long side, defensive sectors like healthcare and utilities may prove a good place to hide, collecting dividends and waiting for markets to sort themselves out. As to cash, which investment advisors tend to dismiss, it's beating stocks by 4.89% this year.

2016 Market Predictions

It's time to take stock of markets in 2015 and provide our thoughts on where things are headed in 2016. Before we get to the predictions, let's take a look at the consensus view of economists and market mavens heading into 2015 to see what they got right, and what they got wrong.

Consensus forecast for 2015 GDP by economists under a survey conducted by the Philadelphia Federal Reserve Bank at this time last year was for 3.00% growth. This view was confirmed in a similar survey of the Wall Street Journal on January 5, 2015.  Now, with only one day remaining in the year, it looks like 2015 GDP will be closer to 2.00%, a substantial miss. Not surprising, really. In a recent report of Goldman Sachs, researchers found that the consensus forecast for GDP has been wrong in 13 of the past 16 years with economists consistently erring on the side of optimism.

Stock market predictions are equally skewed it turns out. With the S&P 500 wavering on either side of flat for the year, the consensus forecast of stock gurus by CNN Money for 2015 was for a gain of 8% on the year (the index is at 2063 as of this writing, in the red for the year). Nonetheless, stocks still trade at over 19x trailing earnings, a historically high market multiple.

Predictions for the bond market were even further from the mark, with market forecasters expecting a substantial rise in bond yields (and decline in bond prices) for several years now. Yet the UST 10-year currently stands at 2.29% (versus 2.22% this time last year). Hardly the drubbing professionals were expecting. 

This having been said, let's take a look at where things could be headed in 2016.

GDP will likely slow further from its tepid pace of 2015 as the dollar strengths, global demand weakens and oil (as well as other commodities) continue to drag down the energy and materials sectors. With the economy reaching full employment (irrespective of the falling labor participation rate) gains in personal income will likely be limited. While the argument can be made that a low unemployment rate increases the leverage of workers over management, income gains from this source will be far lower than moving people from unemployment to employment, as reflected by a lowered unemployment rate. 

At the same time, consumers continue to be concerned about the economy and their personal levels of savings, as reflected in a rising savings rate. Rising savings with limited income gains spells trouble for retailers and consumer spending more generally. Don't look for any gains in governmental spending either in an election year. At the same time, a strengthening dollar jeopardizes corporate profits and exports. Piece it all together and it's hard to make an argument for rising GDP in 2016.

In this environment, and with stocks at lofty levels, the market will be vulnerable. Against a backdrop of Fed tightening volatility will be inevitable. Profit margins will compress and if p/e multiples contract, the downside for stocks could be pronounced.

US Treasury bonds may present the best opportunity for gain, if the foregoing conclusions about growth and corporate profitability are plausible. With slower growth comes lower inflation, benefiting holders of fixed income instruments. While the Fed may be tinkering at the short end, their ability to control the long-end (absent an unwind of long QE positions) is limited. With a lowered Federal budget deficit forecast for 2016 comes lower Treasury issuance, with an emphasis on the short end, as the Treasury has already so indicated. If there is global turmoil in the year ahead, the fear trade will rush investors into UST, with significant price appreciation a distinct possibility.