Bull markets don’t always – or should I say, rarely – age gracefully. This bull market that started in March of 2009 (interrupted by a violent, but brief bear market in 2011), may be entering its golden years.However, it would likely be a mistake to view an aging bull market as a precursor to an imminent big bear market.
So, what should we expect for the coming year? Before looking forward to 2015, let’s take a brief glance through the rearview mirror.
Through The Rearview MirrorI am sure I could open every January newsletter with the phrase “last year was full of surprises.” Such is the nature of the world – and the markets.
The consensus heading into 2014 was that U.S. equities would likely move up until we got into the late summer/early fall. At that time, given relatively high valuations and the specter of increasing interest rates, most expected a sharp, deep pull back. The “sharp” part occurred – the S&P 500 pulled back from its peak of 2011.36 starting on September 18th, but the index was only down -7.4% by the time it resumed its march higher on October 16th. In other words, if you blinked, you missed it. The market just wanted to go higher. The S&P 500 cash index ended the year up +11.39%.
Commodities, on the other hand, just wanted to go lower. Commodities were the worst performers of the year. The strengthening US dollar and the ongoing oversupply of oil were primary catalysts for the poor performance of gold and crude oil, respectively. The Goldman Sachs Commodity Index ended the year down a whopping -33.87%.
International markets also faced headwinds – the threat of deflation in Europe, coupled with concerns of moving back into recession, loomed large. There wasn’t enough confidence that the global economy was “out of the woods” to substantially bolster international markets – and Russia’s aggressive posture, invading the Ukraine over the summer, only added to the uncertainty. With all of this uncertainty, the MSCI EAFE Index (MSCI, Europe, Asia, and Far East Index) ended the year down -9.33%.
The performance of U.S. Treasury bonds was one of biggest surprises of the year. The consensus as we moved into 2014 was that Treasuries would suffer given the winding down of the Fed's QE (Quantitative Easing) program, as well as the likely increase in interest rates. Treasuries actually moved higher in spite of these factors, however, the rest of the bond market did not fare as well, with the Barclay’s U.S. Aggregate up +5.97%.
For the year, we participated in the majority of the move up in US equities, and were largely able to side-step the debacle in commodities. We participated in rally in U.S. Treasuries through our Risk Managed portfolio, but of course, when any asset class is going up, we wish we had owned more if it. We had small positions in Europe, Asia and Emerging Markets on and off throughout the year in our Risk Managed and Global Equity – ETF Portfolios, but were cautious in our positions given that our models were only neutral-to-moderately bullish.
All in all, we felt we navigated 2014 fairly well, with our portfolios positioned to manage what may be a volatile 2015.
Looking Forward 2015 year has the potential to bring several changes to the macro-landscape, some of which started to take root in 2014 – namely, plunging commodity prices, a stronger U.S. dollar, and a shift towards increased interest rates. Accompanying these events, we expect higher market volatility compared to the 2014.
The ramifications of the rapid decline in commodity prices – oil in particular – have been vehemently debated over the past several months. The financial media has certainly found pundits to argue both sides of the debate – whether weaker commodity prices and a stronger dollar support or detract from global economic growth. From the stock market perspective, however, historical evidence points to the fact that, over time, falling commodity prices and a stronger dollar tend to be bullish for the stock market.
2015 has started with a case of the jitters – with oil prices still searching for a bottom. If we use history as a guide, however, once energy prices stabilize, the market will likely digest the lower prices as a positive.
The other major theme playing out this year is a likely change in Fed Policy. While the latest employment, GDP, and manufacturing data suggest economic improvement, we believe it unlikely that the U.S. economy will grow at “escape velocity,” with GDP above 3.3%. Such rapid growth could trigger concerns over higher inflation, and in return, a more aggressive stance in raising interest rates. Rather, we think a more likely scenario is one of GDP growth between 2.5 – 3.0%, which would result in a more moderate Fed stance, with an incremental rate increase in late spring or summer.
The chart below illustrates stock market prices during the six months leading up to and following the start of an interest rate tightening cycle. If we use this historical analysis as a guide,the S&P 500 has climbed an average of 9.8% during the one year spanning the start of the cycle, with the majority of the gains occurring prior to the initial tightening.
What Could Go WrongValuations continue to be a concern. The median P/E for the S&P 500 is just over 21. If one assess the historical P/E, excluding the bubble period from the late 1990’s to the early 2000’s, the market has been unwilling to push the P/E much above 23, suggesting that there isn’t much room for expansion (see chart below). As we have mentioned before, valuations can remain stretched for extended periods. So, our conclusion is similar to what it was a year ago – stretched valuations don’t necessarily imply an imminent bear market. However, these types of valuations do place increased focus on earnings growth.
Another consideration is whether the bull market experienced in the U.S. will broaden out to other global markets. Europe faces meaningful economic structural challenges; while the European Central Bank has promised further Quantitative Easing, some are concerned that the Eurozone will suffer deflation, possibly falling back into recession.
If, however, Europe gets its economic houses in order, global market confidence will likely be bolstered, resulting in a broadening out of stock market performance. This should bode well for both U.S. and international markets. However, if the the U.S. economy and stock market continues to outpace the rest of the world, this may be viewed as cause for concern.
Finally, if oil prices continue to fall precipitously, and don't find stabilization in the $40 - $50 range, we could be facing a more severe sell-off.
Conclusion Whether we end 2015 still in a bull market is up for debate. What we do know is that current bull market is already the 4th longest in 80 years, and that valuations are stretched.
That said, the U.S. economy seems to have turned a corner – and energy prices have come down substantially - both of which bode well for a continued bull market, assuming oil prices stabilize. Only time will tell, but regardless, our models will help guide us with respect to market exposure in our client portfolios.
Live well…invest well!
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