The Markets

2015 marked the worst year for the US stock market since 2008. The Dow Jones industrial average lost 2.2% while the broader base Standard & Poor’s 500 fell 0.7%. The technology index, known as the NASDAQ, gained 5.7%, primarily because a few stocks, Netflix and Amazon, rose spectacularly during the year. Most asset classes experienced a decline in prices including commodities, oil and gas, precious metals, and six of the ten sectors of the U.S. economy.

In fact, the large technology index was the only one that had positive return. The Dow Jones transportation average was down 17%, the utility average down 6.5%, midsize companies in the US lost 3.7% while small companies lost 3.4%. Investors in common stocks fared better than those in precious metals and energy. The gold and silver index of mining stocks dropped 34% during 2015 while oil service companies declined 25.2%. It has been a rocky ride, especially for investors in energy.

Overall, the energy industry lost 21% in 2015 with oil and gas producers leading the movement downward. Oil experienced its first back-to-back decline since 1998 after OPEC nations effectively abandoned their output limits. Production companies had an average drop of 61% in 2015 and experienced three times their normal volatility. Energy shares overall remain down about 40% since oil prices started to decline in June of 2014.

Overseas, the global Dow Euro Index gained 4% though US investors were unable to benefit from Europe’s small gains because of the US dollars’ appreciation. US investors lost 6.72% in Europe, with Spain and England experiencing the greatest declines. Italy gained 12.7% while Switzerland, normally a pillar of stability, declined almost 2%. In Asia, the Dow Jones Asia-Pacific index declined 2.5% with Singapore declining the most at 14% while mainland China increased 9.4%. This is remarkable given that the Shanghai index, China’s Dow Jones equivalent, plunged 40% in late August and it was only due to Beijing’s intervention that those markets did not shut down completely.

Commodities declined 19% in 2015 with crude oil declining 30.47%, natural gas down 19.11% and gold lost 10.44%. Gold’s role as a safe haven asset is getting lost as the metal heads for its third straight annual decline and its longest slump since 2000. Investors also dumped the natural gas transportation companies in which we are heavily invested. Master limited partnerships were down 40% even though they exhibited continued distribution growth to investors and had some moderate increase in their operating earnings.

Emerging markets had an extremely rough year as well. Brazil, which is undergoing both economic and political turmoil, declined 13.3% while India, whose politicians are making great strides in improving the business climate, declined 5%. Mexico’s stock market was fairly even and it is attracting a great deal of interest for 2016 because the country’s bonds, currency, and stock market fundamentals do not warrant the fear that is generally present when most investors consider investing in emerging markets. Indonesia is another country whose market, like Mexico’s, has been oversold.

The bond markets had a fairly benign year with US treasuries gaining .77%, corporate bonds lost 0.2% and global bonds gained 2%. This even keeled performance is due mainly to central bank intervention that served to provide liquidity to banks and government entities, including Greece and Eastern European countries that are being affected economically by the conflict with Russia.

The Economy

2015 was a difficult year for the US economy. Bad weather on the East Coast plus fear of a default by Greece did little damage to investor returns during the first part of the year but set the stage for a summer decline due to a decelerating Chinese economy and a near meltdown in the Chinese stock market. US corporate earnings were weak, partially due to an extremely strong US dollar and falling oil prices. The materials and industrial sectors were hurt, but the energy using sectors were not helped in equal measure. US unemployment declined significantly, at least according to official statistics, and the housing and banking sectors continued to strengthen. Consumer spending remains strong and this is the bedrock of most local communities’ economic health. The federal deficit fell due to cyclical collections and a decline in some federal spending, though this is expected to reverse itself in 2016. Manufacturing in the US contracted at the end of 2015 at the fastest pace in more than six years, not a harbinger of huge growth prospects in 2016.

Some of the most important developments in the economy are the recent action by the Federal Reserve Bank who has maintained a highly interventionist policy for the last six years. They understand that the central bank needs to pull away from being the main player in the markets. The often-announced end of the Fed’s monetary excess should allow historically normal investment return patterns to reestablish themselves. Profitable companies stocks should outperform unprofitable ones but this has not been the case over the last three years as companies with negative earnings had the largest positive returns. This does not make sense and is unsustainable in the long run.

What is really going on at the Federal Reserve? Their recent increase in the benchmark interest rates of one quarter of 1% is relatively minor but the $1.1 trillion in US Treasury bonds that they hold which will mature over the next three years is a cause of major concern. When the Fed shrinks their balance sheet, will that cause a panic among market participants is the question. It is difficult to read the Fed’s meeting minutes as they are full of technical jargon and I believe they are purposely contradictory. The Fed has different people in various cities send out contradictory messages to test the market’s reaction ahead of taking any steps.

Many people wonder whether the elections have a predictable effect on the markets or the economy. In the past, it has generally been a positive one because incumbents do not want to rock the boat and so

we see things like a major federal budget being passed in December 2015 with little fanfare. Previous automatic restraints on government spending, called “ sequestering”, went out the window and there was plenty of pork to go around. Nonetheless, the federal budget deficit has returned to the long-term average of 2.5% of gross domestic product, the same level as right before the great financial crisis of 2007.

Real wage growth for workers has steadily increased over the last four years and this bodes well for consumer confidence, a mainstay of the US economy. The reported US unemployment rate continues to decline, at least among those still looking for work, and surveys of small businesses show that they intend to hire more people than normal so there is some stability to the US economy and this is a good thing. Inflation may increase slightly, however, as we look for commodity prices to stabilize and wages should continue to grow.

Most analysts expect the US economy to grow somewhere between 2% and 3% in 2016. This would cap an unprecedented 10-year expansionary period. Given the Fed’s recent decision to start to raise interest rates, we expect borrowing rates to rise for a second year in a row and perhaps to see the low quality credit sector fall, which would be in keeping with historical norms. It has been a very long and anemic economic recovery in the US but at least we have had one. Europe’s economies continue to depend on central bank policy support, as does China’s. The Chinese economy has no choice but to reinvent itself as domestically driven as opposed to its previous focus on exports over the last two decades. This means that China may stabilize at a lower employment rate than required to keep its population busy. This could present a need for the political leadership there to take strong autocratic action to prevent internal conflicts inside China between the richer coastal provinces and the arid interior regions.

The Price of Energy

Many of our readers have a strong interest in energy prices and the outlook for 2016. We are in the middle of a producer’s war on a global scale and its effect on prices will eventual force some countries to go out of business. Domestic energy production is starting to decline but at nowhere near the rate required to drive US independents out of the business. Iranian and Iraqi oil production is coming back and this will only serve to make competition with OPEC nations Saudi Arabia and the UAE more pronounced.

Without going into the religious and family political history of the Middle East, the interaction between Russia, Iran, Saudi Arabia and the US will determine who will win this producer price war. Russia is going bankrupt because its two main sources of income – energy and forest products are both in the tank.

Russia is attracting the limelight of the political stage in the Middle East in order to deflect attention away from its domestic financial problems that are, for all practical purposes, unfixable. Out of desperation, Russia has tried to align itself with China, who it hopes will serve as an export market for Russian commodity products. China is undergoing an economic contraction of its own so this strategy is unlike to help Russia out of its structural doldrums.

Iran desperately needs cash and it would love to supplant Saudi Arabia as the major Islamic power in the region. It aspires to become one of the drivers of world oil prices over the next decade, both for the increased prestige it would gain in the Muslim world as well as the economic relief it would provide to the entrenched religious theocracy. Any money that Iran can generate and take out of the pockets of the Saudis furthers their goals and so they have no reason to restrict their output in any way. Saudi Arabia and its allies have made large financial commitments to their restive populations in order to keep political peace so they are going to be unwilling to tighten their belts. Practically all the large players in the energy industry have compelling reasons to continue to produce at almost any price so we may be nowhere near the end of this period of low energy prices.

Here in the US, technology advances have enhanced US energy producers’ ability to find and extract energy. US based energy companies will soon be able to transport and market oil worldwide due to recent Congressional action that removed the prohibition against exporting energy from the US. Everyone wants to survive in the energy business and there is an abundance of financing available to even fringe companies. Even the small and weak players are staying in the drilling business when in former times, they would be shutting their doors.

On the international front, Russia is likely to increase its current effective strategy of challenging the United States because it knows that we are unlikely to respond with military action. For the rest of 2016, the US will wait on the sidelines and purposely be clumsy about challenging Russia in any direct way. We do not have to because the low price of energy will continue to decimate the Russian economy, much as the occupation of Afghanistan did in the mid-1980s. Russia’s extremely unfavorable demographics and their deteriorating financial condition will accelerate to the point where they will take more risks which does not bode well for world peace.

My prediction is that the US and Saudi Arabia will team up and that several nations will come close to going bankrupt over the next few years. While the Ukraine is strategically important as a buffer on Russia’s western borders, it, along with other Eastern European nations, will soon have alternate sources of carbon energy so they will eventually no longer be dependent on Russia’s natural gas supply.

Private credit

For the last 15 years, wealthy individuals and institutional investors such as pension funds, insurance companies, and sovereign nation wealth funds have looked to increase their exposure to private equity. Private equity differs from public equity, most often referred to as listed stocks, in that there are many fewer rules governing private equity and very limited liquidity. It is difficult for investors to get prices on the value of their private equity holdings since there is no one offering to buy or sell these interests on a regular or consistent basis. In addition, generally there are restrictions on with whom and when you can trade holdings in private equity. The opportunities for realizing substantial growth in the value of one’s private equity holdings are supposed to greatly surpass returns available through using publicly traded stocks. It is impossible to know whether greater returns are actually received by private equity investors since the results are not publicly available.

There is now a private credit (lending) market that has developed over the last seven years which is similar in many respects to private equity. Private credit instruments are alternatives to bonds and in this era of ultralow interest rates, private credit has attracted a substantial amount of interest (pun intended). After the financial meltdown of 2007, new laws like the Dodd – Frank severely restricted

traditional banks’ ability to lend, especially to small borrowers. Bank executives openly complain that regulators are forcing them out of traditionally profitable markets and making it almost impossible for them to deal with small businesses. This has opened up an opportunity for non-bank lenders.

Peer to peer lending platforms like lending clubs and other crowd funding methods have garnered some publicity and by connecting people and businesses, they match people with capital with potential borrowers. If you have good credit, you can borrow money at 10% for five years without going through a bank. Operating through the Internet or in person, private credit firms can lend money more quickly while offering lower expenses than banks because they are not subject to the same regulatory burdens. They also do not have physical bank branches to support, large computer systems to maintain or deal with the public. In many cases, private credit lenders specialize in one area and they can operate nimbly on a local level.

Some astute banks are cooperating with private lenders so that they do not lose touch with their clients as these low-cost providers of credit are beating traditional banks out for smaller loans. Most private credit funds are available only to accredited investors, those with $1 million of net worth excluding their personal residence, and often there are $50,000 minimums per investment. Private credit investments are generally not liquid, i.e., if you want to get out of them, it can take several months. Depending on what industry the private lender is involved and their particular practices, private lending risk can be diversified or not. Most private lenders return between 6% and 12% to investors. There are many variables involved from the investors perspective: how long the money needs to be kept in the investment, what kind of (tax) reporting is provided, and of course, the quality of the underlying assets behind the loans.

It is difficult to say how large the private lending area has become because there is no requirement for private lenders to report on their activities to the government unless the private lender exceeds a certain number of investors, crosses state lines, or otherwise treads in certain ways on the turf of traditional banks. We have looked into this area in some depth and some of our clients have decided to experiment with private loans. If you have an interest, please contact Kyle Burns.

Upcoming events and personnel news

Rob: The events held at the 333 Montezuma Gallery were well received. If any of you have not been able to attend, please let us know and we will direct you to the video recordings. As we move towards the end of the first quarter of 2016, the major exhibition piece, the Liminal State Panels, is looking for a new space so if you have any ideas or suggestions, please let me know. My daughter Hannah, 27, is taking organic chemistry this semester and she is applying to the naturopathic medical school in Portland, Oregon. See below for Robyn’s recent activity.

Jeff: I am continuing to recover from the shoulder surgery that I had way back in May 2015 and have progressed to swimming now for exercise and am enjoying that activity. I just scheduled some guitar lessons to assess if my shoulder will allow me to play that instrument again or not yet. In the meantime, I continue to sing intermittently with some jazz combos and that is great fun.

Lauren: The Holidays went by in a blur as I worked away here in the office and out in Tesuque where I live. The property gained a few new additions to the herd of alpaca, bringing the total to nine. I am quite excited for spring and looking forward to having all of that fiber for spinning and weaving. The handspun yarn will be used in a large-scale weaving I have been planning. This will be my first attempt at creating a piece of cloth throughout the whole process from raw fiber to a finished weaving, all done by hand. I am hoping the result will be worth all the effort.

Kyle: 2015 closed out with a busy holiday season. Over Thanksgiving, we visited my family in Cincinnati, Ohio, and while there, celebrated my aunt’s birthday. It has been over ten years since my last visit to Cincinnati and I really enjoyed going back to where most of my grandparents’ generation lived. Soon after Thanksgiving, it was time to celebrate again as my twin sons turned six. My sisters and their families returned to Santa Fe, our childhood home, for the end of year holidays. It was a very blessed 2015 and I am looking forward to carrying the momentum into 2016.

Dana: I enjoyed Thanksgiving holiday with family visiting from out of town. It was an opportunity to do those things like go to Ojo Calente, our local hot springs and Puye Cliff Dwelling on the Santa Clara Reservation. I spent Christmas in Silver City at the edge of the Gila Wilderness area. We stayed at the Bear Mountain Lodge that I highly recommend. Hiking, birding and hot springs abound around Silver City, which is in Southeastern New Mexico. It has a historic main street, groovy coffeehouses and galleries representing a large community of local artists. While there, I enjoyed reading a book about the Mimbres people and their pottery and visiting an old pit house site of theirs along the nearby Mimbres River.

Robyn: After returning to the USA from travelling abroad, I am honored to have found a position at the Rikoon Group working with Rob, Jeff, Kyle, Dana and Lauren. I am happy to be back in my hometown of Santa Fe, NM and will be headed up the mountain on the weekends to snowboard at our local ski area. Twice a week, for an hour, I get to play games and work on storytelling with second graders at Carlos Gilbert Elementary School and next week, I begin rehearsals on a play, “The 39 Steps”, to be performed at the Santa Fe Playhouse from February 26th through March 13th. I am thrilled to be working on this piece, which takes place in the 1930’s, as physical comedy is one of my favorite genres.

Local tea and conference calling dates

Our next quarterly “tea”, roundtable discussion of the economy, markets, and world events, along with cookies and fruit, will be held at 2218 old Arroyo Chamiso, on Tuesday, February 9, from 3:30 PM to 5 PM. Please feel free to bring a friend or email us with questions or topics you would like to see covered at this sit-down event. The quarterly phone conference call, for those unable to attend our in-person event, will take place the next day, on Wednesday, February 10 at 3:30 PM Mountain Standard Time. Please use this call-in number: 1.605.475.6006. The access code is 42