Equities of the large capitalization variety experienced double digit returns while long term Treasuries made surprisingly big gains as global economic forces pushed “safe haven “ government yields down , a reversal from 2013.
Ten year U.S. government yields dropped despite the Fed ending its bond purchase program in October. A 3% yield in January went to 2.17% at year-end versus analysts’ predictions of 3.44% one year ago. The 30 year bonds finished the year at a 2.75% yield versus a year ago Bloomberg forecast of 4.25%.
The IBD Mutual Fund Index which consists of growth oriented funds rose 2.4% for the year far less than the major market averages.
Commodity funds dropped 16.5% as benchmark oil prices plunged nearly 50% mostly in the last quarter of the year.
The S&P 500 (SPX) declined nearly 10% in the October selloff and erased all the gains for the year by October 14th amid Ebola and world recession fears. Energy related sectors were among the worst performers in 2014 dropping further in December as OPEC is no longer limiting supplies of crude oil and shale production in the U.S. reached record levels.
In the last 10 weeks of the year, however , all SPX losses were erased but not before another 5% drop in mid-December after which U.S. markets made new highs as Janet Yellen promised a slow hand on the interest rate rise tiller at the last FOMC meeting of 2014.
Recoveries from recent declines took place at record speed making tactical retreats from stocks and hedging costly. While government debt soared in price, lower quality bonds were negatively affected as energy bonds made up nearly 20% of some high yield portfolios. Negative ripples grew into waves as year-end tax selling put more pressure on prices of effected asset classes which included Energy stocks and MLP’s, negative duration bond funds, plus emerging market bonds and stocks.
Non U.S. stocks finished down in dollar terms as the Wall Street Journal U.S. dollar index rose by 12% against a basket of 16 other currencies.
The primary benchmark MSCI EAFE which excludes the U.S. stocks turned in a negative 6.74 % performance in 2014. The UK, France, and Germany lost 13.5% on average. Japan was -7.4 %. China while slowing its GDP growth to the below 7% level came out of its longer term bear market and made gains as did India while the U.S. was the only positive market otherwise.
Global economic growth experienced notable divergences with European economies slumping from Russian sanctions, few economic reforms, and mere talk of QE with little new action. Northern Europe is producing 1% GDP growth while the Southern countries like Italy are slipping back in recession. Greece may finally depart the EU. These conditions drove yields to historic lows in Europe.
Japan increased its massive QE program with more bond purchases and stock buying. They burst their own recovery balloon, however, with a tax hike increase on consumers pushing them back into recession. President Abe has a new mandate to do more but has yet to address structural reform of the economy. He apparently has not read much about Milton Friedman and the Reagan economic miracle but has embraced the Bernanke approach to Keynesian economic theory.
It’s clear that many developed countries are more concerned about preserving their social safety nets and the status quo rather than reducing taxes, regulations, and government interference. Socialism does not provide jobs like free market policies do.
The U.S. QE program having come to its end as of October has served to repress interest rates but it has made stock and commercial real estate investors richer. Middle class workers still earn significantly less than they did in 2007. There are more people are on welfare than ever before and we have amassed an 18 Trillion dollar Federal deficit. Government policies here and abroad have deep vested interests in keeping interest rates low, without which, payments on deficits and debt would soar.
The question begs what to expect in 2015? Can long term rates go even lower? Economists and Wall St gurus say no but their record is not very good as we have seen this past year. German 10 year rates are 0.50%, Japanese 10 years are 0.31% and, UK Gilts yield 1.72% so why can’t U.S. rates decline further?
If we raise short term rates here while Europe and Japan pursue QE policies and little else the dollar will likely rally drawing more investors to the U.S. Bloomberg consensus forecasts now predict 10 year UST rates of 3.24% in 2015. One top performing bond manager Jeff Gundlach however believes the opposite direction is more likely. From today’s 2.10 % yield he believes we could revisit the 2012 low yield of 1.38 % as global investors wager on a strong dollar and better US growth prospects.
As for U.S. stocks Ed Yardini puts 2015 consensus estimate for the SPX at $126.50 and 2016 at $141.54. That gives us a current forward P/E ratio of 16.2x and 14.5X next year.
While higher than the trailing 5 and 10 year averages low rates, low inflation, low oil prices keep GDP growing and earnings moving up for another year or two.
Markets traditionally move from fear at the bottom of a cycle to euphoria at the top. We have yet to reach the euphoria stage seen in 2000 or the multiples reached in 2007.
We expect a more volatile year with ample opportunities in quality stocks and bonds.
Without a U.S. recession or an inverted yield curve, where short term rates are higher than long rates, financial assets should experience a positive return in 2015.
Douglas Coppola
John Coppola
January 5, 2015
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