It wasn’t a banner year for the stock market in 2015. The S&P 500 basically traded flat, while the widely expected Fed rate hike continually was pushed back throughout the latter half of the year, causing volatility to reemerge into day-to-day trading activities.
By and large, mutual funds suffered the same apathetic fate as most of the major indexes did – treading water all year. While large equity funds held steady or posted slight profits going into the final quarter of 2015, most mutual funds lagged behind. Emerging market funds fared the worst with the collapse of the Chinese stock market, while small-cap funds boasted the only real profits in the industry. Smaller companies that lacked the size to have overseas operations escaped the detrimental effects the U.S. dollar had on larger companies, and the extended environment of lower interest rates has allowed these companies to secure loans and other financing at much better rates than expected for longer periods of time.
As uncertainty climbs back into the marketplace, investors are wondering what 2016 might look like and where they should focus their investments. Should investors expect an encore performance from the mutual fund industry, or will there be some changes in the financial markets next year?
Looking at the Big Picture
The mutual fund industry is dependent on the direction of the economy, both domestic and overseas. While a mutual fund has the ability to shift assets around as needed to underweight or overweight different classes to position the fund in a more or less aggressive stance, it still must operate according to the type of fund it is. In other words, a large-cap blue chip fund might be able to scale back on equities and put more into bonds and short-term cash holdings, but don’t expect it suddenly to engage in short positions and put its holdings into cash to ride out a volatile market.
Increased volatility, though, can be beneficial for mutual funds that have track records for outperforming their peers over time. Increased uncertainty means more opportunities to find inefficiencies in the stock market, and solid fund management will be a key component of success over the next year or more.
Breaking Down Fund Sector Expectations
Large-cap equity funds likely will face continued hardship over the next 12 months as the global economy struggles to keep its head above water. Higher-than-average stock valuations will be a headwind for stocks moving forward, making stock selection more difficult for mutual funds – although there are some positive catalysts, with oil beginning to gain strength again and increased pressure on the U.S. dollar, that could come into play in the latter part of the year.
Bond funds will face a particularly challenging environment over the next year or longer as the Fed begins a cycle of raising interest rates. This will put pressure on these funds as bond values fall across the board and short-term bonds begin to be traded en masse, creating unusually high volatility in this normally stable corner of the mutual fund market.
The sector with the most pain likely will be the emerging-markets space again. The slowdown in China still is working its way through smaller emerging economic countries, and its impact has yet to be fully seen. Geographic-specific funds may post mixed results, with an edge going to countries with limited east-Asian exposure and heightened European exposure.
Small-cap mutual funds will face a difficult environment as well, and aren’t likely to repeat their performances in 2015. Rising rates will hurt these fast-growing companies and slow down expansion projects, while the declining value of the U.S. dollar means their larger counterparts will outperform them as they get earnings boosts from improved foreign-currency exchange rates.
The mutual fund industry faces a stormy outlook in 2016, but there are spots of sunshine to be seen. If oil moves higher at a stable pace, it could be a sign of improved global economic growth expectations. It also would finally knock the U.S. dollar off its pedestal, which would benefit large-cap companies that have been struggling with decreased earnings overseas. Finally, when the Fed starts to raise interest rates, effects will be seen in varying degrees in all aspects of the financial marketplace, with bond funds struggling to keep up, and equity funds seeking the best sector in the market for a new economic paradigm.