Here’s our list:
1. A potential Federal Reserve “Mistake” when it comes to monetary policy. Let’sface it – no one really believes the Fed is going to raise interest rates morethan once this year. Not the bond market(one year T-bills yield 19 basis points), not the Fed Funds Futures market (expected year end Fed Funds are 44.5 basis points), not equity investors (we’re back to up on the year for the S&P 500, an unlikely level if stock investors really thought rate increases were coming… see “1994” for more information).
Still, let’s not forget that great Fed Chairs will occasionally put the U.S. economy into a recession just to prove a point. Paul Volcker did it in the early 1980s to tame inflationary expectations, for example, and that move paid dividends (or coupons, if you prefer) for decades. Now, Chair Yellen has the chance to lift interest rates and show that the Federal Reserve believes the U.S. economy is returning to normal. Not zero-interest-rate normal – truly normal. This would no doubt roil equity markets and likely cause a shallow recession, but it would also signal a definitive end to the post-Crisis world and the dawning of a new and more normal era.
2. Deflation becomes reality. It is a bit amazing that sovereign debt yields are near zero in many developed markets around the world and yet sell-side equity analysts have positive revenue growth expectations for multinational companies and their economist counterparts are not forecasting recessions around the globe. It’s sort of like hearing distant thunder and still leaving the house without an umbrella. Deflation would hurt everything from corporate earnings to labor markets, and it would do so for a long time. See “Japan” for more information…
3. Greek tragedy. While we believe neither the Greeks nor the Eurozone would benefit from Greece leaving the euro, February will be an important month to work out the details of an exit or a longer stay. A disorderly and emotional exit, where Europe throws Greece’s clothes on the lawn and changes the locks, benefits no one. And the same goes for Greece staying out all night with Russia or China and not at least calling home or texting to check in. Greece and the Eurozone need some serious couples counseling, but we wish them the best on their journey and will stay friends with both of them no matter what.
4. A little math and valuation talk. Fun fact, courtesy of Jeff Gundlach of Doubleline Capital: U.S. stocks have never rallied 7 years in a row. Ever. The only six year periods were 1898 – 1903 (followed by an 18% correction in 1904) and 2009 to 2014. Another fun fact: U.S. stocks trade for 27x trailing 10 year average earnings. The average since 1880 is 16.6x. Bottom line: yes, maybe things are different and the rally can continue in 2015. But things have to be seriously different – not just a little different.
5. Currency wars. A strong dollar may be in the long term interests of the U.S. economy and the American people, but over the short term it can be a bit of pain. Yes, imports become cheaper but that increases the risk of deflation. And it crimps the corporate earnings of companies that do business overseas and potentially dampens equity market valuations as well. Most of all, a rapidly appreciating currency creates uncertainty, and that’s rarely a productive environment for businesses or investors.
6. Geopolitics. Throughout human history there have rafts of violent, corrupt, power hungry nations and leaders; Putin, ISIS, Iran, North Korea… these are nothing new and relative to history they are actually a pretty sad B-team. Not the Mongols, or Stalin, or even Mao – they knew a thing or two about world domination. Still, even our current crop of ne’er-do-wells could upset the fragile global economic recovery if they so choose and as we’ve noted equity valuations do not seem to incorporate this risk.
7. Oil. We’ve saved the best for last, in that the volatility in crude oil markets has clearly been the number one driver of U.S. equity market prices in 2015. In the near term, we are clearly going to lose 100,000 or more high paying oil field jobs in the U.S. – that much is a lock based on historical precedent. Looking further out, consumers will eventually shift their expenditures to other items. Will that generate jobs that pay the same +$90,000/year than the energy sector pays? Probably not. But that shift in spending could create more jobs than the energy boom of the last decade. The point is that we don’t know how this tradeoff will play out. And that uncertainty makes it negative.
We hope that we have appeased the ancient bear gods with this token offering. The bull may end up winning again this year – there’s a long way to go in 2015. At the same time, the bear deserves more respect than he gets at the moment.