The 3 Major Stories in the Global Economy for the Year
I would like to wish all of our readers a happy and prosperous 2015! As we did last year, I wanted to take a moment to reflect on the previous year, and take a look at the events that shaped the economy last year, and potential impact on 2015. The bull continued to run in the US, but other economies and investment asset classes lagged behind.
Volatility continues to be the norm. For the year, the S&P rose +11.5%, the Dow gained +7.5%, and the MSCI EAFE (developed international) lost -8.1%.
Here are the 3 major stories from 2013 we believe will continue to impact 2014:
Oil Prices Fall Hard…Where to Next?
With crude oil briefly trading below $50 a barrel on Monday, many wonder if the commodity is oversold and due for a rebound. However, one prominent analyst, Citigroup’s Ed Morse, believes there is further downside. Last March, Morse correctly predicted $75 a barrel global oil prices, back when it was trading above $100. His team at Citigroup are now calling for global and U.S oil prices to average $63 and $55 a barrel this year, respectively. They believe that the 2014 price decline was supply driven, and that the oversupply condition will continue to drive prices even lower before recovering somewhat in the second half of 2015 and into next year.
For more thoughts on the price of oil, please see our last blog entry—a special perspective on oil.
The Relationship Between Stocks & Interest Rates
We know the general inverse relationship between bond values and interest rates, but predicting equity trajectory during periods when interest rates rise is a little bit tougher. An article from the Wall Street Journal provides the history of S&P 500 returns when the U.S. Federal Reserve boosts rates. The author reviewed 14 periods during which the Fed was boosting short-term interest rates since the S&P 500 index was launched in 1957. He calculated the returns for the index in each period from the month when rates bottomed out through the month when rates peaked. The periods ranged in length from several months to more than four years. The average return for the S&P 500 during all four periods was 9.6%, including dividends. The S&P 500 fell in only two of the 14 periods, both in the early 1970s. Other researchers have pointed out similar conclusions although they point out that the stock market has tended to undergo increased volatility (an average decline of 8%) around the initial instance of rate hikes.
It might not matter. According to bond guru Bill Gross, it will be difficult for the Fed to raise rates in light of continued sluggish global growth and low inflation. He has a weak outlook for growth this year in both developed and emerging markets. Moreover, he feels the strengthening U.S. dollar and falling oil prices will also contribute to the Fed holding off on raising interest rates. The Federal Reserve has not raised short-term interest rates in nine years, but the consensus expectation is for a rate hike in mid-year.
Divided Government--Officially
The US government officially became divided, with Republicans seizing control of both houses of Congress. Expect a whole lot of nothing as President Obama does not have the votes from his party in either house, and the Republicans lack a super-majority to override any veto. There will likely be many “symbolic” legislation sent by Congress to the President’s desk, but the larger issues will likely be ignored.
Tax Reform is probably the single largest economic issue that needs to be addressed (but likely won’t). Not only does it affect the net income of every American by its arcane complexity, it also affects the long-term viability of social security, calculation of Medicare premium payments for retirees, business planning (e.g. hiring for growth), and much more. Again I do not expect any of this to be addressed by a fully divided executive and legislative branch.
Looking ahead, we're optimistic about 2015. We do expect US equities to slow their pace of growth. Corrections & bear markets are part of the normal investing and economic cycle, and statistically we are due for either. That said, there are still many prospects for growth and opportunities in other asset classes. Long term economic trends are still heading in the right direction. Although it's impossible to predict market trajectories with accuracy, we're always on the lookout for both dangers and opportunities for our clients, and we look forward to supporting you in the year ahead!
Articles chosen and summarized by the First Allied Asset Management, Inc. investment management team. First Allied Asset Management provides investment management and advisory services to a number of programs sponsored by First Allied Securities and First Allied Advisory Services. First Allied Asset Management individuals who provide investment management services are not associated persons with any broker-dealer.
