Happy New Year!
“Yesterday is gone, tomorrow is yet to be, today is all we have, let us begin” Mother Teresa
Well 2014 is gone but I think it makes sense to reflect on what happened in the economy and financial markets. In my January 2014 Outlook I highlighted several themes I anticipated for the year as follows:
For 2014 the five major themes I anticipated were:
- Economy – continued, but slightly expanding, growth in global economic activity, with US GDP growing between 2.5% to 3.5%. Globally, Europe should emerge from recession, new policies in Japan should move its economy forward and China is showing signs of stabilization.
- Interest Rates – gradually increasing interest rates toward 3.5% (basis US 10yr Treasury) based on the Federal Reserve reducing its monetary stimulus (bond buying) but continuing to hold short-term rates near zero. I expect this to be a slow and incremental process.
- Inflation – should remain below the Federal Reserve’s target level of 2.5% (basis personal consumption expenditures PCE rate). This should mean that the US dollar appreciates but gold and other inflation sensitive commodities will likely lose value.
- Stocks – equity market will slowly grind higher based on the improving economy yielding higher corporate profits. However, I do anticipate at least a 10% correction at some point during the year and higher volatility (fluctuations) than we saw in 2013. My target is between 6% and 10% increase for the S&P 500.
- Bonds – the combination of an improving US economy, a less accommodative Federal Reserve and better potential returns in the equity markets will likely mean 2014 will be a tough year for bond investments. My target for the Barclays Aggregate Bond Index is between 0.0% – 2.5%. I am more concerned about bonds once short-term interest rates start to rise, which I don’t expect until sometime in 2015.
At this time last year no one predicted Russia would invade Crimea, that ISIS would rise as a destabilizing power in the Middle East, that oil prices would decline almost 50% or that the Republicans would sweep control of Congress. These all had an impact.
So how did my predictions for 2014 fare?
- Economy – the US economy did better than I expected, with US GDP growing at a 5% annual pace (US Commerce Dept 12/23/14). Europe, on the other hand, saw its economic growth stifled by the sanctions placed on Russia due to their actions in Crimea/Ukraine.
- Interest Rates – I, along with virtually every analyst on Wall Street, got this one wrong. The Federal Reserve did stop their direct monetary stimulus (bond buying) and did continue to hold short-term rates near zero. However, interest rates actually declined from 3.03% on 12/31/13 to 2.17% on 12/31/14 basis US 10yr Treasury. (source: Yahoo Finance)
- Inflation – My forecast here was spot on. Inflation remained low, and actually declined due to the drop in oil prices. The US Dollar had its strongest year since 2005, appreciating versus other major currencies like Japanese Yen and the Euro. Gold declined 2.19% (source: Yahoo Finance symbol GLD), The Bloomberg Commodity Index (BCOM), which tracks 22 products from crude to copper, lost 17 percent last year.
- Stocks – I was pretty close on equities. Stocks gained 11.39% for the year and we did see a correction of 9.83% from the all-time intra-day high on 9/19/14 to the intra-day low on 10/15/14. (basis S&P 500 source: Yahoo Finance)
- Bonds – bonds did much better than I expected due to the decline in interest rates. Remember that as interest rates decline, bond prices go up and vice versa. For the year the Barclays Aggregate Bond Index gained 5.97% (source: barcap.com)
For 2015 the five major themes I anticipate are:
- Economy – the acceleration in US economic growth should continue but exports will be a drag on GDP, given the weakness in other economies. I anticipate GDP growth of 2.75% – 4.25% for 2015. Globally, I think the Eurozone will benefit from cheaper oil and the likely start of quantitative easing (monetary stimulus by the European Central Bank). Japan and China will have slightly improving economies.
- Interest Rates – In the US the Federal Reserve will begin gradually increasing short-term interest rates by mid-year. This should put upward pressure on longer term interest rates toward 3.5% (basis US 10yr Treasury). I expect this to be a slow and incremental process. Internationally, I expect Europe, Japan and China to maintain monetary stimulus policies that should keep their interest rates low throughout the year.
- Inflation – I expect to see an uptick in wages and a stabilization in oil prices that should push inflation up into the Federal Reserve’s target level of 2.5% (basis personal consumption expenditures PCE rate). The increase in US interest rates, coupled with the likely drop in international interest rates should mean that the US dollar continues to appreciate with inflation sensitive commodities likely to lose value.
- Stocks – Given the increase in the US equity market over the last 2 years I expect smaller gains – in the 5% to 10% range for the S&P 500 – for 2015. I expect European equities will get a boost from monetary stimulus as will Japan and China due to lower cost of importing oil. My target for developed international market equities is 10% – 15%, while emerging markets will likely return only single digits. I do anticipate higher volatility (fluctuations) than we saw in 2013 or 2014.
- Bonds – I am going to stick with my outlook from 2014 for bonds. The combination of an improving US economy, rate increases from the Federal Reserve and better potential returns in the equity markets will likely mean 2015 will be a tough year for bond investments. My target for the Barclays Aggregate Bond Index is between 0.0% – 2.5%. I am more concerned about bonds once short-term interest rates start to rise, which I don’t expect until mid-year or later in 2015.
I estimate the probability of these themes occurring at 55%, with a 15% probability that we don’t achieve these targets and a 30% probability we exceed them. Factors that could potentially disrupt global progress include (a) gridlock in the US due to the divided government (President: Democrat, Congress: Republican); (b) the Federal Reserve raising interest rates too fast or too soon; and (c) European leaders not taking policy steps to improve the overall European recovery. As always, the impact of unforeseen “black swan” events are unknown. Factors that could help deliver better results primarily relate to global fiscal and monetary policies that are supportive of economic expansion.
I will put out a mid-year report in July 2015 on where we stand versus these themes and make adjustments for the balance of the year accordingly.
January Calendar of Events (comments and additions for future months are always welcome)
- January is National Blood Donation Month. I’m donating on the 29th. How about you?
January 5th My granddaughter Isys turn 9. They grow up way too fast.
January 10th My better half, Eloise’s birthday.
January 15th the 5th anniversary of my independent practice – thank you to all my loyal clients.
I will soon be announcing some exciting changes to my practice – stay tuned !
January 19th Martin Luther King Day. Let’s pray for more racial tolerance and understanding.
So yesterday is gone, tomorrow is yet to be, we only have today – let us begin!
Sources: RiverFront Investment Group, CNBC
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