It is once again time to put down in print in one place some pretty specific speculations on what could happen next year. We do this every year with the intent of trying to get investors to think about what could happen and factor that into their decisions on how to adjust their portfolios to take advantage of opportunities while at the same time being aware of the risks. And, maybe, do something about it. One can always speculate about a possible occurrence. What I have tried to do is include those elements where I believe the odds are high enough of an occurrence to take into account in a portfolio. In addition, this may bring to the fore some things that could happen and what to look for to indicate a possible mid-term adjustment. You may want to take a look at the mid-year review we did of the 2014 expectations to get a sense of how we saw the world a year ago. It might give you some perspective on how much weight to put on this year’s observations. Let’s proceed.
United States—Growth Continues and the US Defines Its Own Economic Path
Let’s first discuss the United States. The US remains the market of most focus as much technologically, politically and economically is taking place here and is a primary determinant of what happens in the rest of the world. The US is not fully isolated from what is happening elsewhere, but can, if it so chooses, make its own economic, political and geopolitical decisions. It can only get in its own way. So what is the path for the next year?
Economically, the US experiences real GDP growth that varies by quarter between 2.5% and 4.5% with growth generally surprising to the upside as a result of lower energy prices working their way positively through the economy. The lower energy prices will increase volatility of reported numbers on employment and growth, but the trend is up. Export trade is not as robust as we move through the year and begin experiencing some impact from the strong dollar. On the other hand, the lower cost of imported oil offsets growing demand for other imported goods producing less of a negative impact on trade balances and GDP. While lower energy prices produce financial accidents in the oil patch and geopolitically, the ripple effect of lower feedstock, transportation and production costs are, on balance, positive for the US economy. At the same time, in spite of cutbacks in the energy sector, overall employment ultimately continues to grow. A tight labor market continues to get tighter with wages, a lagging indicator, growing faster than they have in some time. Capacity utilization, which is already at levels seen before 2008, moves higher, putting some pressure for price increases and likely increasing capex. The Fed takes notice.
The mix of sectors and companies that benefit from lower energy prices is significantly different from those that generated excess returns in the last several years. The Fed, to some extent ignoring what is happening outside the US, gives stronger signals on timing of a rate increase in 2015. The combination of credit concerns, primarily coming from the energy sector, and the potential for a rate rise also affect performance in the interest rate sector. I anticipate that the halo effect of deserved wider credit spreads in the energy sector produces opportunities to lock in some decent returns in the rest of the high yield and high grade corporate sectors. I believe the real money is made on the negative side of the credit markets. The yield curve gets even flatter.
The Rest of the Americas—A Mixed Picture Offers Opportunities
On balance the lower oil prices do have a negative impact on Canada. With Canada’s housing market looking a bit overextended we start seeing a few leaks in the Canada story on both the credit and equity side.
Mexico also sees some impact from the lower energy prices in terms of revenues and the privatization of its energy sector. It still continues to be one of the good stories of growth, reform and development in the world.
Venezuela likely moves into real or technical default with major political disruptions and uncertain actions from the ruling party. Venezuela’s problems ripple through to the Caribbean, in particular, Cuba, where subsidized oil flow becomes problematic. The timing of the Chanukah opening of relationships between the US and Cuba likely does stem from a long period of talks, but the oil situation has no doubt increased some sense of urgency for Cuba to find another partner to replace the string of subsidizers since the revolution. This will likely produce another bargaining chip for the new Congress, as the President needs support to go beyond what he can do administratively. Cuba will get more headlines than it deserves, but maybe the Cuban people will start moving toward a better life as a result.
Argentina continues to muddle through toward the ultimate payment in some form at some discount of its outstanding debt obligations. As a result of the Argentine issue with a few holders being able to avoid participating in a restructuring approved by a majority of the debt holders, there is talk, and possibly real action, on new rules for sovereign debt structures to avoid a similar problem in the future. This likely raises the cost of sovereign debt in general and may change the nature and mix of the buyers.
With Brazil’s economy under some pressure and oil as a savior looking a bit less like one, Rousseff makes some adjustments to policy becoming more markets friendly. This is not without some domestic turmoil. The uncertainty substantially increases volatility in the markets and the currency.