Volatility will be the new normal in 2015. That's the overriding theme that emerged in my annual survey of investment professionals who got it right last year. And if this week's market action is any indicator, their prediction is already being borne out. Stocks soared on January 8, with the Dow Jones industrial average gaining over 300 points, the fourth straight session of triple-digit moves. Interest rates and oil prices have also gyrated.
Volatility could also be called the old normal, given how common it was before the relatively tranquil years after the financial crisis. "We're likely to get a lot more volatility than we've become used to," said William Miller, who runs the Legg Mason Opportunity Trust. "Every time we get a correction or even close to it, everybody flips out. I'd say that's more of an observation than a prediction."
Miller returns for a fourth consecutive appearance in this column on the strength of his forecast for the stock market last year. He was far more bullish than most, and said then that he expected the Standard & Poor's 500-stock index to gain "in the low to midteens," which turned out to be exactly right. (It gained 13.7 per cent.)
"It's going to be a lot trickier this year," he told me last week. "But I'm very bullish on the United States economy over all. I'm looking at high single-digit to low double-digit gains for the S&P 500, and I could see the S&P 500 gain 15 per cent if things break the right way. Absent some weird geopolitical thing, I'd be very surprised to see negative returns."
Volatility was also the forecast, if that's the right word, at the AlphaSimplex Group in Cambridge, Massachusetts, the research and asset management firm founded by Andrew W Lo, author of the "adaptive markets hypothesis," which examined whether markets are rational, and director of the Massachusetts Institute of Technology's Laboratory for Financial Engineering.
Whether the fund can repeat last year's success remains to be seen, since it's little more than a year old. (AlphaSimplex has two other liquid alternative mutual funds with longer track records and just started a global macrofund.) The firm's model currently shows that risks in the US market are rising. "We're still at 130 per cent but we're close to ratcheting that down," Wilkinson said. "We're watching very carefully for the contagion risk of developed non-US markets."
Whither bonds?
If 2014 was a tough year for active stock managers, it was even worse for fixed-income managers. A year ago, almost everyone expected higher rates, including a bearish Bill Gross, a founder of the investment firm Pimco, who told me then that investors should expect "slim pickings" and stick to cash or low-yielding money market funds. (It was an especially turbulent year for Gross, who abruptly left Pimco and joined Janus Capital Group.) His advice for this year is much the same, "Be cautious and content with low positive returns in 2015," he recently wrote in his monthly newsletter.
In what has to be considered the biggest market surprise of 2014, interest rates dropped sharply and bonds rallied. The Barclays United States Aggregate Bond Index returned just under 6 per cent. United States Treasuries with longer maturities fared even better.
Douglas Kass, president of Seabreeze Partners Management (and a widely followed market analyst), was one of the few to forecast lower rates last year in his annual list of "surprises" for 2015.
This year, in what he called "the polar opposite of what I saw last year," he's predicting no less than the "end of the three-decade bull market in bonds," he told me this week.
"Rates will go lower at first," he said. "That will shock people, and everyone will throw in the towel on higher rates." (So far, he seems to be right about that.) But, he said, once people realise that the European Central Bank's stimulus policies are too little, too late, he expects European rates to rise, followed by those in the US.
A fund that capitalised on lower rates last year was Delaware Investments' Extended Duration Bond Fund, which returned over 17 per cent.
This year, Delaware's fixed-income specialists are predicting a modest rise in rates, to just over 2 per cent for 10-year United States Treasuries. "We feel the fundamentals suggest rates can stay in the low 2 per cent area, and could end up lower because of dislocation in other markets," said Roger A Early, Delaware's co-head of fixed-income investments.
He said he was "open-minded" about whether the Federal Reserve will raise the federal funds rate this year, as nearly everyone expects.
"With some of the stress we've seen, relative to energy and commodity prices, and with deflationary trends in places like Europe, if those continue, I don't think it's a given the Fed will move interest rates in the second or third quarter."
Whither oil prices?
In nearly every forecast for the year, the wild card is oil. The steep fall in 2014, from more than $100 a barrel to less than $50, surprised and rattled many investors, stoked fears of deflation and battered emerging market economies, even as it put more cash in consumers' pockets. Almost no one saw it coming, but one who did is Michael Levi, senior fellow for energy at the Council on Foreign Relations and author of "The Power Surge: Energy, Opportunity and the Battle for America's Future."
"Early in 2014, oil prices had been high and steady for a long time, and people extrapolated that this would be indefinite," Levi told me this week as prices fell below $50 a barrel. "That didn't make any sense."
Looking ahead, "Anything is possible," he cautioned, "but all the conditions for high volatility remain in place. That's the natural state of the oil market unless a cartel is in control. Part of the lesson from last year is that a small mismatch in supply and demand can result in a large and rapid change in prices. That works in both directions. If there's an increase in global growth, geopolitical disruptions or a faster shutdown in North American production, then oil prices could definitely go up."
Nor, he said, should Saudi Arabia's potential influence be ignored. He noted that the kingdom waited until oil prices got into the $30-a-barrel range before curtailing production in the midst of the financial crisis. "Just because Saudi Arabia hasn't acted yet doesn't mean it never will," he said.
© 2015 The New York Times
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