It’s that time of year where the media is flooded with people making predictions for the coming year. Opinions range from extreme bullishness to extreme bearishness with some being utterly ridiculous. Each one is hoping that their prediction is different from the others so if they are right they will become famous for predicting whatever it is they predicted. Therefore, I encourage you to take any predictions with a grain of salt.
Rather than make specific predictions, our role as your financial advisers is to provide a fair assessment of the condition of the economy and markets and highlight the headwinds and tailwinds we face going forward. 2014 was a challenging year for tactical strategies (not just us, but the industry in total) in that we had four fairly quick drops of less than a 10% correction followed by quick bounce backs. A larger, longer correction is likely to happen eventually but may or may not happen in 2015. The Advance & Protect Strategy is intended to protect against these drops and can work well if the decline lasts more than a week or two. Realizing that different clients and their respective accounts have different risk tolerances and tax situations it may be appropriate to use buy and hold strategies in some situations. Having said that there will be corrections and bear markets and we believe Advance & Protect, a tactical strategy, is the best way to protect in those situations. Losses are asymmetrical, in other words it takes a bigger gain to recoup a loss. The bigger the loss the harder it is to gain back. For example, 50% loss requires a 100% gain to recover. A 10% loss only requires an 11% gain to recover. A tactical strategy can help protect against large losses.
Many had predicted this year that interest rates would continue to rise but instead they fell with the 10 year treasury at 3.044% on January 2nd ending 2014 at 2.17% despite the FED ending their bond purchases in October. The end of bond purchases did not have an immediate effect on interest rates but did contribute to a sharp increase in the US dollar against other currencies. The strong dollar is a double edges sword. It helps keep inflation low as the cost of everything we import drops. It also creates a headwind as everything we export is more expensive in foreign currencies. All indications are that the FED will increase short term interest rates this year. However, long term rates are largely set by the markets. The FED would likely need to aggressively sell bonds to raise long term rates but they haven’t indicated that is even given consideration at this point.
Very few analysts predicted the sharp drop in oil prices that we have seen this year. Never the less, this is major change in the economic landscape. Nations depending on oil exports, especially those with higher productions costs and less economic diversity, will be hurt the most. The US, while still a large consumer of oil, will face a headwind at these oil prices as layoffs loom for drilling in the oil fields. The tail wind will be the US consumer who has more discretionary income. I would be watching statistics on consumer spending very closely for keys on the US economy. However, consumer spending alone may not be enough for US growth to accelerate as many consumer items are imported. We really need increased spending on both consumer goods and housing for growth to be maintained at current levels.
The other issues I would consider going forward are:
- It’s been over three years since a correction of over 10%. Having said that it is by no means certain that this will happen in 2015. The S&P 500 went from 1991 to 1998 without a 10% correction and again from 2003 to 2008 without a 10% drop. Prior to the last 25 years, corrections of 10% or more came more frequently. These longer correction free periods led to bigger bear markets in 2002 and 2008. My belief is the longer we go, the less caution investors will have, which will eventually mean a bigger adjustment is necessary. I don’t think we are there yet but we must be careful not to through caution to the wind.
- The European Central Bank has indicated they will start quantitative easing after the first of the year. Japan is increasing its stimulus. China is taking steps to boost its economy. These may help turn around the economies there. However, these efforts may also likely increase the dollar further against these currencies with the resulting damage against US exports. The US economy is the bright spot in the world economy. The FED’s mandates are price stability and full employment. At what point will the strong dollar be a concern if it effects full employment or creates deflation? The FED may actually delay rate increases.
- The Obama administration is encouraging loosening mortgage lending restrictions. While we experienced the effect of overly loose lending perhaps the pendulum has swung too far the other way. If lending standards are moved to a more accommodative stance it will help US economic growth. We just need to be careful not to go too far.
Stocks were lower in this holiday shortened week.
In the Advance & Protect Strategy we added the Hennessy Cornerstone Midcap Fund.
In particular this past week:
- Markit (yes that’s how it’s spelled) reported that Chinese Manufacturing in December fell to 49.6 from 50.0 in November. Anything below 50 represents a contraction. The slowdown in China has been blamed on the housing sector.
- The US Labor Department reported that initial jobless claims rose to a seasonally adjusted 298,000 in the prior week, more than expected. The four week moving average also rose by only 250 to 290,750. Still claims have been below 300,000 for the longest period since 2006.
- The National Association of Realtors reported that pending home sales rose 0.8% in November and 4.1% from a year ago.
- The Institute for Supply Management reported that the US Manufacturing Index fell to 55.5 in December from 58.7 in November. Anything over 50 represents expansion.