At this time of year we like to take a look back at the investing world over the past 12 months and see if that gives us any insights as to where markets might be going in the year ahead. Let’s start with the easier part: assessing where we have been.
If you only look at large-cap U.S. stocks, 2014 has been another strong year. As we write this a couple of days before the end of the year, the S&P 500 Index is up about 13% for the year. But if you look around a little more broadly, things don’t look quite so good. Smaller capitalization U.S. stocks, as measured by the Russell 2000 Index are only up 4.4%, having spent a good part of the year in negative territory. When you look abroad, things look worse. The MSCI EAFE Index, one of the most widely followed international indices (EAFE stands for Europe, Australasia and Far East), is down 6.6%.
The bond markets have done better than many people expected, as interest rates stayed low. Here again the U.S. markets outperformed much of the rest of the world with the broad-based Barclays Aggregate U.S. Bond Index gaining about 5.5% for the year. Because of the strong U.S. dollar, the Barclays Global Aggregate (unhedged) gained only 0.3% on a dollar basis.
High yield bonds have also had a less than stellar year. The B of A Merrill Lynch High Yield Index has a total return of 2.4%. The prices of bonds in the index are actually down more than 4%, but the income from the bonds nudged the total return of the index into positive territory.
So much for the easy part. Where do we see markets going from here? As always, the markets will be buffeted by many competing forces. On the positive side: the U.S. economy appears to remain strong; corporate earnings are still rising; lower energy prices will put money back in consumers’ pockets and corporate merger and stock buyback activity may reduce the supply of available stock.
On the negative side: the economies in many other parts of the world look less healthy than the U.S.; stock valuations appear to be toward the high end of their historical ranges and interest rates may finally rise in 2015, which could spook investors (although historically the stock market has usually performed well in the early stages of a slowly rising rate environment). For history buffs, there is one other potential negative: the U.S. stock market has risen for six straight years, and according to one market strategist who claims to have looked back as far as 1875, it has never risen for seven years in a row.
So where does that leave us? Longtime readers know that we strongly believe that no one – least of all your Editor – can accurately forecast where the market is going in the future. But that said, we also believe that no investment newsletter can get away without making a market forecast at this time of year. Therefore, after considering the various market currents and counter-currents, we predict that the S&P 500 Index will rise by 4% in 2015. While that number pales in comparison to recent years, it may look good compared to many other investment sectors in the coming year.
We remain wary of bonds because interest rates have to rise sometime, and 2015 may finally be the year when it happens. Also, with respect to high yield bonds, we expect defaults and bankruptcies to pick up in 2015 as we discuss more in the next article.
Other Articles from January 2015 Turnaround Letter