A sneak peek at 2015 – What to keep an eye on
The fundamentals that have fueled equity gains in recent years remain in place. Even as the Fed ended its controversial bond-buying program last October, the fed funds rate is expected to remain at historically low levels through at least the end of 2015 and possibly beyond. Moreover, the European Central Bank continues to hint that a more ambitious plan is in the works, as it battles a severe disinflationary environment. Simply put, central bank generosity has historically been a tailwind for stocks.
But as I cautioned previously, let’s not get carried away. Let’s keep a balanced approach. Let’s adjust our approach when changes in your personal situation or goals make our current stance less than optimal. While strong fundamentals remain in place, risks never disappear, even in a diversified portfolio. We can manage but not eliminate risk. So that leads to the next question – what may be some of the events that could create volatility in 2015.
1- The year ended with oil near $50 per barrel. I recently saw a story in Reuters that noted $150 billion in energy projects around the globe face the axe. That means there will be winners and losers at current prices, though the net gain to the economy should be positive.
Meanwhile, Russia is undergoing a wrenching adjustment, as its energy-dependent economy must adapt to the new reality. The Russian ruble has fallen sharply this year, and Russia’s central bank said its economy could shrink by as much as 4.7% in 2015 if oil averages $60 a barrel.
A 1998-like crisis that briefly walloped stocks doesn’t appear to be on the horizon, but any contagion that seeps out of Russia could create volatility at home.
Then there has been the steep selloff in junk bonds tied to the energy sector. While Treasury and investment grade yields fell last year, high-yield debt rose. Some of the rise can be blamed on expectations the Fed will eventually raise interest rates, which could crimp some highly-leveraged borrowers.
But a big part of the increase can be blamed on default fears in the energy patch amid a re-pricing of risk in high-yield energy bonds. If concerns were to seep into other sectors of the junk bond market, we could see a spillover into stocks.
2- One test the market faces early this year: Greece is set to elect a new president in January, and there are worries the far left could take the top spot.
While political leaders on the left favor staying in the euro-zone, they want to renegotiate the terms of the Greek bailout. Markets rarely enjoy grappling with an added layer of uncertainty.
3- Slowing growth in China could dampen growth at home. Odds are fairly low as the U.S. simply isn’t dependent on overseas demand to drive its economy. So far, U.S. growth has accelerated in the face of global jitters.
4- Will we get volatility around the Fed’s first rate hike in nearly a decade? There are no guarantees when it comes to Fed policy, but if U.S. employment and economic growth continues at the current pace, the Fed has signaled rates will start rising in 2015. Although it is doing its best to telegraph its intentions, markets could get jittery in the interim.
5- Emerging market anxieties. A stronger dollar and a Federal Reserve that is expected to begin raising rates could pressure developing countries that have sold bonds in greenbacks instead of their local currencies, forcing them to repay loans in more expensive dollars. Foreign reserves (akin to a rainy day fund) could minimize any pressure, but it’s something that bears watching.
6- Liquidity is like oxygen to the market. A brief surge in U.S. Treasury prices and the steep but short-lived stocks selloff in October can be partly blamed on a temporary lack of liquidity. Some cite well-intentioned regulations put in place after the 2008 financial crisis.
7- Cyber-attacks. North Korea’s alleged attack on Sony quickly comes to mind. It’s impossible to forecast, but the outside chance of a big event can’t be completely discounted.
8- Geopolitical fears. War or geopolitical instability has historically caused short-term losses. Whether the Arab spring, Russia’s incursion into Ukraine, or the rise of ISIS (ISIL) in Iraq, heightened uncertainty is not a friend of investors.
Those who know me know that this is where I beat the drum for appropriate risk assessment and appropriate diversification. Volatility doesn’t necessarily mean a major selloff in the market, and in fact could lead to new record highs as in 2014. I will continue to work with clients to find their balance between their own risk tolerance and their desired investment return.
John A. Davidson, CFP®
KylesHill Financial Planning
But as I cautioned previously, let’s not get carried away. Let’s keep a balanced approach. Let’s adjust our approach when changes in your personal situation or goals make our current stance less than optimal. While strong fundamentals remain in place, risks never disappear, even in a diversified portfolio. We can manage but not eliminate risk. So that leads to the next question – what may be some of the events that could create volatility in 2015.
1- The year ended with oil near $50 per barrel. I recently saw a story in Reuters that noted $150 billion in energy projects around the globe face the axe. That means there will be winners and losers at current prices, though the net gain to the economy should be positive.
Meanwhile, Russia is undergoing a wrenching adjustment, as its energy-dependent economy must adapt to the new reality. The Russian ruble has fallen sharply this year, and Russia’s central bank said its economy could shrink by as much as 4.7% in 2015 if oil averages $60 a barrel.
A 1998-like crisis that briefly walloped stocks doesn’t appear to be on the horizon, but any contagion that seeps out of Russia could create volatility at home.
Then there has been the steep selloff in junk bonds tied to the energy sector. While Treasury and investment grade yields fell last year, high-yield debt rose. Some of the rise can be blamed on expectations the Fed will eventually raise interest rates, which could crimp some highly-leveraged borrowers.
But a big part of the increase can be blamed on default fears in the energy patch amid a re-pricing of risk in high-yield energy bonds. If concerns were to seep into other sectors of the junk bond market, we could see a spillover into stocks.
2- One test the market faces early this year: Greece is set to elect a new president in January, and there are worries the far left could take the top spot.
While political leaders on the left favor staying in the euro-zone, they want to renegotiate the terms of the Greek bailout. Markets rarely enjoy grappling with an added layer of uncertainty.
3- Slowing growth in China could dampen growth at home. Odds are fairly low as the U.S. simply isn’t dependent on overseas demand to drive its economy. So far, U.S. growth has accelerated in the face of global jitters.
4- Will we get volatility around the Fed’s first rate hike in nearly a decade? There are no guarantees when it comes to Fed policy, but if U.S. employment and economic growth continues at the current pace, the Fed has signaled rates will start rising in 2015. Although it is doing its best to telegraph its intentions, markets could get jittery in the interim.
5- Emerging market anxieties. A stronger dollar and a Federal Reserve that is expected to begin raising rates could pressure developing countries that have sold bonds in greenbacks instead of their local currencies, forcing them to repay loans in more expensive dollars. Foreign reserves (akin to a rainy day fund) could minimize any pressure, but it’s something that bears watching.
6- Liquidity is like oxygen to the market. A brief surge in U.S. Treasury prices and the steep but short-lived stocks selloff in October can be partly blamed on a temporary lack of liquidity. Some cite well-intentioned regulations put in place after the 2008 financial crisis.
7- Cyber-attacks. North Korea’s alleged attack on Sony quickly comes to mind. It’s impossible to forecast, but the outside chance of a big event can’t be completely discounted.
8- Geopolitical fears. War or geopolitical instability has historically caused short-term losses. Whether the Arab spring, Russia’s incursion into Ukraine, or the rise of ISIS (ISIL) in Iraq, heightened uncertainty is not a friend of investors.
Those who know me know that this is where I beat the drum for appropriate risk assessment and appropriate diversification. Volatility doesn’t necessarily mean a major selloff in the market, and in fact could lead to new record highs as in 2014. I will continue to work with clients to find their balance between their own risk tolerance and their desired investment return.
John A. Davidson, CFP®
KylesHill Financial Planning