The S&P 500 Index closed 2014 with a total return of 13.68%. That comes after a return of 32.39% in 2013 and a return of 16.00% in 2012. The broad market has only registered double digit returns for three consecutive years six times in the last 150 years. No one knows for sure what 2015 will bring, but another year of double digit returns may be tough to pull-off.
During the latter half of 2014, the Fed ended its quantitative easing, known more commonly as QE3. Thus, the government is no longer adding to the monetary base which has been a boon for stocks. This removal of support may be countered by the quantitative easing in Japan and the easing from the European Central Bank. Japan has taken a big bet on monetary stimulus to bolster its economy, far greater than the U.S. experiment. Because of the lack of growth in the Eurozone and the complexities in its constitution, the European Central Bank is taking its own unique path in easing.
Potentially aiding growth in both regions, as well as the U.S., is the drop in oil prices. Should the price of oil stay at current levels, the decline would approximate a $200 billion tax cut for U.S. consumers. With more cash in hand, spending could increase.
China will also be a major beneficiary of lower oil; however growth has waned from the double digit pace it achieved over the past thirty years. The government is doing everything it can to keep it at the current 7% level.
Geopolitical risks remain high in the Middle East and Russia. Although the Middle East has been in crisis since I can remember, the current strain on the region caused by ISIS and the Syrian conflict, in today’s environment, increases the chance for a destabilizing terrorist response.
The Russia-Ukraine crisis is of particular note. While it has had little impact on Western equity markets to date, the decline in oil prices, coupled with the West’s sanctions, has brought the Russian economy to a very precarious state. President Vladimir Putin has proven that economics is not his priority and who knows what he will do if he feels “cornered.”
Closer to home, the U.S. economy should continue to lead the rest of the developed world. Divergence in growth will also lead to divergence in monetary policies. While Japan and Europe will continue to ease, the Fed is expected to tighten. Should the U.S. economy continue on its current pace, it is reasonable for the Fed to raise rates in the latter half of the year. One outcome would be a continued appreciation of the dollar. Exporters and multi-nationals that rely on a significant portion of their sales to come from exports could be hurt. This could have a bigger negative effect on the companies and the equity markets than the economy. Exports only account for 14% of U.S. economic growth while foreign revenues account for close to 40% of S&P 500 company revenues. An appreciating U.S. dollar could also cause instability in the global capital markets, especially for emerging markets that are particularly exposed to the dollar.
Since the end of QE3 on October 29th, market volatility has increased from its ultra-low levels. We expect higher volatility to remain as the markets adjust to a less accommodative U.S. monetary policy. In 2014, equity markets hit two speed bumps: the spring sell-off in internet and biotech stocks and the fall decline in global risk assets on growth fears. If you sold out of your long-term investment plan during these periods, you made a mistake. Not so much because you mistimed the market, but because your portfolio may have had risk beyond your tolerance. Jumping in and out of the market is the biggest threat to reaching your goals. Discerning quick corrections from disastrous sell-offs is only possible after the fact. This is why it is important to build a well-diversified durable portfolio, one that can weather the good times, as well as, the storms. As a result, your portfolio will always have winners and losers, but this year’s winners could be next year’s losers and vice- versa.
Washington Trust Bank believes that the information provided was obtained from reliable sources, but we do not guarantee its accuracy. Neither the information nor any opinion expressed constitutes a solicitation for business or a recommendation of the purchase or sale of securities or commodities.
Washington Trust Bank.