2014 marked the sixth year of the global bull market in stocks, bonds and real estate. This is becoming one of the longest bull markets since the 1990’s nine year winning streak. Throughout the past six years, many investors and the media have continuously doubted the strength of the economy and the potential for financial assets – stocks, bonds and real estate – to continue their upward spiral. On balance, these views could not have been more incorrect as each of these asset classes has trounced the paltry returns in money market funds. As we look forward into 2015 we must ask ourselves how much longer the bull market can last and what data points we can use to judge when to further reduce risk to protect the great gains we have achieved together over the past six years.
Ultimately the price of financial assets is a reflection of economic growth and corporate profits. On this point, the rise in asset prices is quite justifiable. Regardless of doubt, the global economy has been expanding throughout the last six years. Though the US economy has been more stable, other foreign economies have enjoyed even faster growth during this period. Typically, at this stage of the economic cycle, growth starts to slow as the economy matures. However, today we seem to be witnessing just the opposite: stronger growth, particularly in the US which has experienced a significant decrease in unemployment.
Given these strong fundamentals, one might consider taking on more risk. However, it is important to note that most of this good news is already in the price of stocks, bonds and real estate. A further increase in investment returns will be predicated on a further continuation of economic growth. Stocks are not overvalued and, based on our research and many valuation models, are nowhere close to where bull markets often come to an end. Rather, stocks and other financial assets are fairly priced so keeping a close eye on economic conditions will be a key to returns in 2015.
As we have mentioned in recent quarters, the fate of the market can be tied to a number of factors which include geopolitics, inflation/rising commodity prices, or Federal Reserve Policy. On the geopolitical front, the world was less than stable in 2014 and looks similar in our 2015 outlook. The recent collapse in oil prices may make the geopolitical situation worse for those countries dependent on higher oil prices – particularly Russia. Coincidentally, on the inflation front, lower oil prices are a boon to global consumers and certain sectors of the global economy. Our research suggests that oil prices may not recover for some time to come, which is a net positive for global economic growth. All things considered, if left alone, it appears that global growth should continue in 2015. However, this could be derailed by Federal Reserve (the Fed) Policy – the wild card to our 2015 outlook.
While most investment firms predict a 5-10% gain for stocks and real estate in 2015, our view is different. We think it is likely to be greater or less than these figures dependent on what action, if any, the Fed takes this year. Typically, in periods of stronger economic growth, the Fed eventually begins raising interest rates to slow the economy in an attempt to give the expansion greater longevity. This is tricky business. If they raise rates at a gradual pace or not at all, stock prices should enjoy a surprisingly good year in 2015. However, raising rates too quickly has historically thrown the global economy into recession. Financial assets – in case you have forgotten the bear markets of 2008, 2002, 1990 etc. – are quick to judge this mistake. Rising stock prices are dependent on economic and profit growth and recessions destroy both. Unfortunately, the Fed’s track record of raising rates at the “right” pace is not very good – they often do so too fast, forcing the economy into recession. We have great faith in Janet Yellen the Fed Chair, and we feel she is particularly aware of the risks of incorrect Fed policy. We will be watching the Fed’s actions and listening closely to Fed policy meeting details as we judge the risks in your investment portfolio.
We are cautiously optimistic about the prospects for the economy and financial assets in 2015. However, to further manage the risk of your portfolio, we will continue to monitor your portfolio’s asset allocation, sector exposure and carefully use stop loss orders to mitigate the risk of catastrophic decline.
If you have experienced any significant change in your financial circumstances or would like to discuss your portfolio, please let us know at your earliest convenience. All of us wish you a great, successful and healthy 2015.
Sincerely,
Your Team at Main Street Research