After a Tumultuous 2015, Investors Have Low Expectations for Markets

'Not a lot of things to get enthusiastic about, and a long list of things to be worried about,' says one investor By Dan Strumpf Dan Strumpf The Wall Street Journal BiographyDan Strumpf @DanStrumpf [email protected] Updated Jan. 1, 2016 6:59 p.m. ET

After a year of disappointment in everything from U.S. stocks to emerging markets and junk bonds, investors are approaching 2016 with low expectations.

Some see the past year as a bad omen. Two major stock indexes posted their first annual decline since the financial crisis, while energy prices fell even further. Emerging markets and junk bonds also struggled.

Others view the pullback as a sensible breather for some markets after years of strong gains.

While large gains were common as markets recovered in the years after the 2008 financial crisis, many investors say such returns are growing harder to come by, and expect slim gains at best this year.

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"You have to be very muted in your expectations," said Margie Patel, senior portfolio manager at Wells Fargo Funds who said she expects mid-single percentage-point gains in major U.S. stock indexes this year.

"It's pretty hard to point to a sector or an industry where you could say, well, that's going to grow very, very rapidly," she said, adding that there are "not a lot of things to get enthusiastic about, and a long list of things to be worried about."

As the year neared an end, a fierce selloff hit junk bonds in December, while U.S. government bond yields rose only modestly despite the Federal Reserve's decision to raise its benchmark interest rate in December, showing investors weren't ready to retreat from relatively safe government bonds.

For the U.S., 2015's rough results stood in contrast to three stellar years. After rising 46% from 2012 through 2014, the Dow Jones Industrial Average fell 2.2% last year. The S&P 500 fell 0.7%.

While most Wall Street equity strategists still expect gains for U.S. stocks this year, they also once again expect higher levels of volatility than in years past. Of 16 investment banks that issued forecasts for this year, two-thirds expect the S&P 500 to finish 2016 at a level less than 10% above last year's close, according to stock-market research firm Birinyi Associates.

Some investors say a pause for stocks is normal for a bull market of this length, which has been the longest since the 1990s. Including dividends, the S&P 500 has returned 249% since its crisis-era low of 2009.

In the past, flat or near-flat years for stocks often have preceded big gains. In each of the three years after 2011, essentially flat for the S&P 500, the index posted a double-digit percent rise.

Yet the slowdown in economic growth around the world remains a major hurdle for global markets. A deceleration in China and other emerging economies led the International Monetary Fund to repeatedly cut its growth outlook last year. It expects global growth of 3.6% in 2016.

For 2016, analysts expect S&P 500 profits to expand 7.6%, according to FactSet, but investors say a deeper growth slowdown, another slide in oil or further gains in the dollar could curb that figure.

Peter Stournaras who manages $16.2 billion in large-company stock funds at BlackRock Inc., said he expects U.S. stocks to rise in line with earnings growth, which he expects to come in between 5% and 10% this year. But he added that "there are things that are much more concerning this year than they were at the end of" 2014, including the turmoil in energy and high-yield bonds.

Emerging markets, a trouble spot for investors in 2015, continue to look shaky, as the dollar rallies and a commodity rout persists. Last year, emerging-market stocks fell 17%, according to MSCI Inc., and bonds in local currencies lost 15%, according to J.P. Morgan Chase & Co., amid concerns over the underlying economic health of many countries.

Capital flight could be a taxing issue for countries that rely on foreign investments to fund their deficits. The problem: Companies and countries that have borrowed heavily in dollars but whose income is denominated in local currencies have become pinched as the dollar has strengthened. Further, their borrowing costs will likely increase as the U.S. central bank tightens monetary policy, which could further boost the dollar.

Plunging commodity prices, fueled by waning demand amid slowing global growth, have hamstrung many emerging economies that rely on income from exporting raw materials.

"I am not necessarily in a hurry to load up on emerging markets," said Jurrien Timmer, a strategist at Fidelity Investments. He notes that low commodity prices and slow growth could remain a hurdle, and advises sticking to developed-country markets for now.

One reason for optimism: Economic growth in emerging economies still outpaces the developed the world, and is expected to rise to an average of 4.5% in 2016, up from last year's 4%, which would mark the first acceleration since 2010, according to the IMF. However, that outlook was cut several times in 2015.

The bond market tripped up investors in 2015, but some are optimistic that the more troublesome corners of the market have stabilized.

The junk-bond market has steadied somewhat since its December selloff, and most of the turmoil has remained confined to the energy and mining sectors, where investors feared persistently low commodity prices could lead some low-rated firms to default.

Some investors say the selloff lowered prices enough that bargains are now available, and that the relative strength of the U.S. economy bodes well for the junk-bond market overall.

"We could actually start off the year with a pretty nice rally" in corporate-debt markets, said Jim Sarni, managing principal at Payden & Rygel. Mr. Sarni says his firm is generally favoring bonds from companies in the retail and health care sectors, though it is avoiding energy names.

Mr. Sarni said he is holding less Treasury debt compared with a bond index. But he doesn't expect the 10-year Treasury yield to rise significantly in a world of low growth and contained inflation.

-- Min Zeng, Carolyn Cui and Mike Cherney contributed to this article.

Write to Dan Strumpf at [email protected]

Appeared in the January 4, 2016, print edition as 'Investors Brace.'