The nerve-racking “V-shaped” performance of the stock market in October, when the S&P plunged by nearly 10% but then recovered by month-end to a new all-time high, has given way to a more docile period. Buoyed by a market-friendly election outcome and reassuring news about U.S. job growth, the broad indices continue to grind higher. As investors anticipate another solid finish for stock prices in 2014, it is time to start thinking about the investment landscape that awaits us next year.
We expect the U.S. economy to continue to make steady progress in 2015. After 4 years of approximately 2% real GDP growth, we believe growth could accelerate next year to the 2.5% - 3.0% range, driven by continued gains in jobs and increased spending by businesses to expand capacity.
The primary threat we see to economic growth in the U.S. is a severe downturn in Europe, which could bring export growth to a halt and unleash more deflationary pressures here at home. The positive aspect of Europe’s economic predicament is downward pressure on U.S. interest rates. As a result, despite our outlook for faster U.S. growth in 2015, we expect only a modest rise in long-term interest rates. Low rates should keep the wheels of commerce turning, as borrowers continue to benefit from especially attractive financing terms.
The boom in U.S. energy production, coupled with sluggish demand from the large commodity importers such as China, should keep oil prices well contained. Lower energy costs have been a major tailwind for U.S. consumers and businesses in 2014, and we expect that benefit to persist next year. With Republicans now in control of both the Senate and the House, the passage of the long-delayed Keystone XL pipeline is much more likely. Derided by environmentalists, the proposed pipeline would nonetheless boost construction hiring, keep a lid on domestic energy prices, and further the rebound in U.S. manufacturing activity.
Perhaps the biggest unknown awaiting investors in 2015 is the impact of the Federal Reserve’s tightening actions on financial markets. It is widely expected that the Fed will begin to raise short-term rates next year in an attempt to “normalize” monetary policy. The Fed’s goal is to raise interest rates enough to provide some ammunition to be able to lower rates during the next downturn, but not enough to derail the economic momentum of the past few years. While speculation runs rampant in the financial press about the timing of the first increase, the more important question is how fast the Fed will act in raising rates. Our view is that the Fed will move very methodically, but we expect heightened volatility in the markets next year as investors position for the expected changes.
The other question facing equity investors is price. As stocks bump up against the high end of normal valuation levels, how much incremental appreciation can one expect? Our view is that U.S. stocks can post another positive year in 2015, but returns are likely to be lower than in the recent past. The conditions that have driven the market to all-time highs (easy monetary policy, low interest rates, falling energy prices, and declining inflation) will likely remain in place, but high valuations are likely to limit the potential gains.
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