As I think about last year and the upcoming year, I am moderately optimistic. Last year began with most pundits prognosticating an increase in interest rates. Many were calling for a 3.5% yield on the ten year treasury. In fact, rates declined and the ten year treasury ended just under 2.20%.
I believe this occurred for a few reasons. First, the economy continued to grow only modestly leading investors to remain cautious. Second, the geo-political risks caused a continued flight to quality. Russia’s antics in Ukraine created a highly disruptive force leading to a flight of capital seeking a safer haven e.g. U.S. treasuries. Finally, weak economies in Europe and China caused foreign investors to seek safety.
According to Morningstar, Utilities and healthcare were among the top performing sectors indicating that investors remained defensive. Under-performing sectors included energy, basic materials, industrials, and consumer discretionary. I believe 2015 will be the year that companies implement more aggressive growth initiatives which should lead to job growth, capital investment, and increased mergers and acquisitions. Following are a few catalysts which I believe could fuel the equity markets for 2015.
While such a rapid decrease in oil prices is disconcerting, I believe this has happened for a couple of reasons. Supply in the U.S. energy complex is the leading reason followed by softening economies in China and Europe. The downside is the spillover effect this will have on oil exporting nations such as Russia, Brazil, and Venezuela. The upside is that U.S. consumers are benefiting by lower energy prices. This not only helps consumers but also helps energy-dependent companies such as delivery companies, UPS and FedEx, retailers, airlines, distributors, and manufacturers. In fact, almost any company heavily dependent upon oil should see improved profits.
The housing market could be a big driver for domestic economic expansion. For this to occur, the job market needs to improve further. That is, good paying jobs need to be created. If this happens and if interest rates remain muted, then I expect the housing market to be a large contributor to U.S. GDP in 2015. Housing prices, as shown in the Case Schiller Index, generally improved throughout the first half of 2014 and have flattened out for the remainder of the year. This has resulted in increased equity. This is fueling home renovations as demonstrated by the share price performance of companies such as Home Depot and Restoration Hardware.
Another major consumer discretionary sector, autos, saw continued improvement but this has yet to translate to increased share prices for the domestic manufacturers. Ford and General Motors share prices were flat-to-down while auto production resumed a nearly record annual production of 16.4 million units according to ScotiaBank. The U.S. average auto age is 11.4 years according to the U.S. Department of Transportation. I expect low oil prices and the increasing need to replace autos to support record-level auto production and contribute to an improving U.S. GDP. Interest rates and attractive financing along with an improving job market should underpin favorable fundamentals.
I don’t expect a lot to get accomplished in Washington this year except for increased discussion in favor of tax reform. The U.S. has a major need to revamp the corporate tax system; however, I am not optimistic that we will see that with the current administration. I do expect to see this emerge as a major issue for the 2016 Presidential election. The mere possibility of reform will be viewed as a positive.
The potential impact on the U.S. economy is enormous with a benefit being the repatriation of huge sums of money being locked up overseas. This would afford companies the opportunity to reinvest in their businesses leading to job growth, capital investment, and increased mergers and acquisitions. Unfortunately, I think we will have to wait until 2017 or 2018 to see the benefits.
Declining interest rates led to a huge run in utilities and the Affordable Care Act provided the fuel for a continued rally in healthcare. I expect this year to be a turn in fortunes for cyclicals, financials, and consumer discretionary companies. I also expect to see some technology companies benefit from corporate investment.
I remain cautiously optimistic. With continued gridlock in Washington, there should be little opportunity for lopsided, anti-growth policy-making to ensue. I believe, the positive, domestic fundamentals continue to outweigh the negatives. The rest of the world still has “some wood to chop” with the EU and China most likely to incorporate stimulus measures to combat slowing economies.
Keep an eye on Russia as it has painted itself into a corner. I only hope that this does not lead to a substantial increase in instability there and in the region. A resolution in Ukraine could be a positive for Europe and would add stability to the region.
While not always pretty and certainly not always popular, the U.S. and democracy has once again demonstrated the strength of our system. Things aren’t perfect and potential pitfalls remain. However, in my view, there are more horses than there is manure.
Jay Cohen is the founder and President of Monterey Wealth. He can be reached at 404-201-2284 or by email at email@example.com. Please check out the many resources at their website www.montereywealth.com