2014 Markets in Review & 2015 Outlook
January 1, 2015
Another year is behind us. It was another record year at Polaris Wealth. We passed the half billion assets under management mark thanks to your trust and the hard work performed by the dedicated team at Polaris Wealth. I could not be more proud of where we are today. The S&P 500 experienced another solid year, up 11.39% for the year. This was the third year in a row with at least a 10% return. This is the first time the S&P 500 has had three consecutive years of greater than 10% returns since the 1995-1999 run.
The S&P 500 also had an incredibly consistent year, with only two corrections greater than 5% and no corrections over 10% during the year. Incredibly, the longest losing streak for the S&P 500 in 2014 was three days. This is the shortest number of consecutive negative days for any calendar year since 1928, when this data began being tracked.
The Polaris Wealth 2015 Market Outlook
Each year I’m asked to give an outlook for what’s ahead for the upcoming year. I hate making predictions. No one has tomorrow’s newspaper and investing in an educated guess is simply foolish. As you know, we manage money in a dynamic manner for exactly this reason. We allocate a higher percentage of an account (based upon your risk tolerance) to stocks when our technical and fundamental research indicates a higher probability of success in equities. Conversely, we allocate more to bonds when our research indicates more risk or a lower probability of making money in the stock market. So rather than predicting the future I will tell you what I like about the current market and what keeps me up at night.
What I Like About Our Current Markets
The S&P 500’s technical indicators look strong, with the index above its 50 day moving average, and the 50 day moving average above the 200 day moving average (this is a good short-term indicator).
The Strength of the US Economy
The United States economy looks solid at the moment, while not showing any signs of inflation. While there is not a direct correlation between the economy and the stock market, any weakness in the former could have a negative impact on the latter. As you can see in the chart below, the Chicago Fed National Activity Index is showing strong moderate growth (seen in the lower half of the graph).
U.S. Deficit is Under Control
Even though our government currently holds a record $18 trillion in debt, our deficit spending has come under control. Currently our annual deficit is $436 billion, or 2.5% of GDP. This is significantly lower than where we were at the height of the Great Recession (10.6% deficit to GDP ratio) or during the Reagan and first Bush administrations (5.9% and 5.4% respectively). Don’t get me wrong, we’re still spending more than we’re making. But we’re making good strides in the right direction, with a 1% improvement from last year.
Unemployment continues to improve, with our most recent U3 unemployment figure at 5.56% (U6 unemployment is currently at 11.2%). This is a marked improvement from the 10%+ unemployment during the Great Recession. Education and age are large determining factors for unemployment.
The markets seem properly valued based upon the near-term historical averages. So while we’ve experienced six consecutive years of positive market movement, with the last three years over 10%, the markets don’t seem overvalued from a historical perspective, as seen to the right.
The average company in the S&P 500 continues to show significant health, with record earnings per share, historically high profit margins, and less debt (as seen to the right).
As you all know I’m a big believer in understanding history and how it may impact our markets. While no market repeats history, nor should you invest purely based upon how history has acted, intelligent investors take it into consideration. Historically, the third year of a President’s term is the strongest for the markets.
What Keeps Me Up At Night
A strong U.S. dollar
On the surface a strong U.S. dollar sounds great. The main reason that the dollar is strengthening is due to our economy. While our economy has been improving slowly by historical terms, our economy is improving faster than most of our international trading partners. The International Monetary Fund (IMF) estimates that the U.S. economy should expand 3.1% in 2015 compared with 1.3% for the Eurozone and 0.8% for Japan. Emerging market countries are also slowing down. IMF estimates 2015 GDP growth of 4.4% for this group, the lowest since the financial crisis.
A continued drop in oil prices
Oil prices have been dropping for a number of reasons. One is the strengthening of the U.S. dollar, making oil more expensive for foreign buyers due to exchange rates. Another reason that oil prices have been dropping is due to an economic slowdown in Europe and emerging markets countries (as mentioned above). Lastly, oil production has been increasing due to new and more efficient extracting practices. Lower oil prices have the largest impact on low income U.S. households. The cost of gas represents a larger percentage of their total income. As I mentioned in our last educational e-mail, while dropping oil prices are positive for consumer consumption, unfortunately it is not good for our country’s GDP. Not all of the money that is saved at the gas pumps will filter its way back into our economy. Rather than turning around and spending the entire savings, Americans may choose to pay down debt, put the additional money into savings or invest it. None of these activities will positively impact our GDP. Our GDP may continue to grow for a lot of reasons. Energy is only 10% of our overall market valuations. But a weak energy sector could have a ripple effect in many other areas of our economy.
The market’s game of musical chairs
As mentioned earlier, the S&P 500 has just completed its third straight year with a greater than 10% return. This is also the six straight year of positive returns. While we are not in uncharted territory, we should keep a protective eye out for risks that might derail the S&P 500 from a seventh straight positive year. As you can see below, there have been three other time periods that have produced a similar length of positive returns. In the first two cases, the market had a one year pull back before producing greater returns in the years that followed. The 2000s, on the other hand, ushered in the beginning of our most recent “secular bear market.”
I am not predicting that the S&P 500 will have negative returns in 2015. At some point, however, the music will stop and we will want a chair to sit in so we can continue to play the game.
As I wrote this review, I went back and read some of what I wrote in previous years. While I was more right than wrong, no one can predict the future with complete accuracy.
As in the beginning of most market years, there are always some possible headwinds that could impact the markets. There are just as many reasons why the markets could experience a seventh year of positive returns. This is why we tactically manage money to play “defense” when it makes sense to play “defense,” and “make hay while the sun shines.” It is also why we change the weighting of our allocation to areas of strength and lower or eliminate segments of the market that are experiencing negative pressure. We are happy to review how we make our clinical, tactical decisions for you in your next portfolio review.
As always, I welcome your comments and questions.
Jeffrey J. Powell
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